SMALL BUSINESS 

ADMINISTRATION

Actions Needed to 

Ensure Planned 

Improvements 

Address Key 

Requirements of the 

Development 

Company (504) Loan 

Program

Report to Congressional Requesters

March 2014

GAO-14-233

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-14-233, a report to 

congressional requesters

March 2014

SMALL BUSINESS ADMINISTRATION

Actions Needed to Ensure Planned Improvements 

Address Key Requirements of the Development 

Company (504) Loan Program

Why GAO Did This Study

Title V of the Small Business 

Investment Act of 1958 established 

what is commonly referred to as the 

“504 loan program” to provide small 

businesses with financing for long-term

fixed assets, such as land and 

buildings. SBA oversees the program, 

and about 270 CDCs issue “504 loans” 

that generally cover up to 40 percent of 

project costs. The program aims to 

encourage economic development 

primarily by enabling small businesses 

to create or retain jobs within their 

communities. This report examines (1) 

the lending standards and performance 

measures SBA has established to help 

ensure that loans meet key 

requirements, as well as 504 loan 

performance, and (2) SBA’s processes 

for reviewing CDCs’ eligibility to 

participate in the program, loan 

applications, and CDCs’ compliance 

with program requirements. GAO 

analyzed SBA data, SBA’s lending 

standards and compliance process

documentation, and interviewed SBA 

officials and 10 CDCs selected based 

on factors such as size and location. 

What GAO Recommends

GAO recommends that SBA issue 

guidance on calculating jobs created 

and retained, expand its review of 

CDCs’ annual reports and risk-based 

reviews of selected CDCs to include 

assessment of data on jobs supported 

and compliance with the retainedearnings requirement, and expand its 

process for renewing the delegated 

authority of certain CDCs to include a 

review of CDCs’ certifications of 

borrowers’ ability to repay made prior 

to loan closing. SBA generally agreed 

with the recommendations and outlined 

steps it plans to take in response.

What GAO Found

The Small Business Administration (SBA) has established lending standards to 

protect against default and has measured program performance, but lacks 

guidance on determining the number of jobs supported by 504 program-funded

projects. SBA’s guidance for certified development companies (CDC)—nonprofits 

that provide funding to small businesses to promote local economic development 

in their communities and are certified by SBA—includes credit underwriting 

standards for determining ability to repay. SBA also has established performance 

indicators—such as the number of small businesses assisted and jobs 

supported—for the 504 loan program. However, SBA does not describe how 

CDCs should calculate jobs created and retained by 504 projects, a key program 

requirement. Federal internal control standards require control activities that help 

participants report information accurately. Without specific guidance, SBA cannot 

ensure that CDCs are calculating this information consistently or accurately. 

GAO’s analysis of SBA data showed that 504 loans approved in fiscal years 

2006 through 2008 had the highest 18-month default rates, which correlated with

trends in the private sector for commercial real estate loans. 

SBA has processes to review (1) CDCs’ eligibility to participate in the 504

program, (2) loan applications, and (3) CDCs’ compliance with program 

requirements. The agency is revising some of these processes and expects to 

finalize the changes by June 2014. However, GAO identified two key areas 

where additional improvement is needed:

• Jobs supported and retained earnings. SBA has guidance for reviewing 

CDCs’ annual reports (used to assess CDC eligibility) and for risk-based 

reviews of CDCs’ compliance with program requirements. However, this 

guidance does not require SBA staff to review supporting documentation on 

jobs supported or assess whether CDCs are investing retained earnings in 

local economic development, as required by regulation. Federal internal 

control standards require control activities to ensure that program 

participants report information accurately and comply with requirements. 

Without reviewing CDCs’ information on jobs data and compliance with the 

retained-earnings requirement, SBA cannot be assured that information on 

jobs supported is accurate and CDCs are supporting economic development 

activities as required.

• Certification by CDCs with delegated authority. SBA provides initial approval 

for a 504 loan upon application, but the 504 loan is not closed until after 

project-related construction is complete (which can be up to 4 years after 

initial approval). SBA has delegated to certain CDCs additional authority to 

close a 504 loan. For example, at closing CDCs with this delegated authority

can certify that borrowers are still able to repay a 504 loan rather than submit

documentation to SBA for approval, as regular CDCs are required to do. SBA 

renews delegated authority periodically but does not verify that CDCs can 

support these certifications. Federal internal control standards require 

agencies to verify compliance with requirements. Without verifying these 

certifications, SBA lacks assurance that CDCs with delegated authority are 

following program requirements. 

View GAO-14-233. For more information, 

contact William B. Shear at (202) 512-8678 or 

shearw@gao.gov.
Page i GAO-14-233 504 Loan Program

Letter 1 

Background 3

SBA Has Established Lending Standards and Measured 

Performance, but Lacks Guidance on Determining Jobs 

Supported 9

SBA Reviews CDC Eligibility and Loan Applications, but Does Not 

Confirm Compliance with Some Requirements 23

SBA Is Implementing a New Approach to Monitoring CDC 

Compliance but Has Not Yet Documented Key Processes 35

Conclusions 43

Recommendations for Executive Action 44

Agency Comments and Our Evaluation 45

Appendix I Objectives, Scope, and Methodology 47

Appendix II Comments from the Small Business Administration 52

Appendix III GAO Contact and Staff Acknowledgments 54

Tables

Table 1: Selected Requirements of the 504 Loan Program 9

Table 2: Performance Indicators for the 504 Loan Program, Fiscal 

Years 2010-2012 15

Table 3: Loans Approved, Screened Out, or Declined, Fiscal 

Years 2010-2013 31

Table 4: Number and Results of Risk-Based Reviews, Fiscal 

Years 2007-2012 43

Figures

Figure 1: Number and Dollar Amount of 504 Loans Approved and 

Disbursed, Fiscal Years 2003-2012 8

Figure 2: Typical 504 Project Structure 12

Figure 3: Default Rates by Cohort Year (Year 504 Loan 

Approved), Fiscal Years 2003-2012 18

Contents
Page ii GAO-14-233 504 Loan Program

Figure 4: Comparison of Trends in Nonaccrual Rates for 504 

Loans and Private Sector Commercial Loans, Calendar 

Years 2004-2013 20

Figure 5: Default Rates by State, as of March 2013 22

Figure 6: 504 Loan Application Reviews 29

Figure 7: Description of the Proposed SMART Process, as of 

January 2014 37

Figure 8: Proposed Risk-Based Review Process 38

Abbreviations

ALP Accredited Lenders Program

ASM Abridged Submission Method

CDC certified development company

HUBZone Historically Underutilized Business Zone 

OCA Office of Capital Access

OCRM Office of Credit Risk Management

OFA Office of Financial Assistance

SBA Small Business Administration

SLPC Sacramento Loan Processing Center

SOP Standard Operating Procedure

This is a work of the U.S. government and is not subject to copyright protection in the 

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without further permission from GAO. However, because this work may contain 

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Page 1 GAO-14-233 504 Loan Program

441 G St. N.W.

Washington, DC 20548

March 6, 2014

The Honorable Sam Graves

Chairman

Committee on Small Business

House of Representatives

The Honorable Mike Coffman

Member

House of Representatives

Small businesses play a critical role in the health of the U.S. economy 

and employ a large number of U.S. workers. Given their importance, the 

U.S. government has established programs that provide credit and other 

support to new and existing small businesses. One such program is a 

loan guarantee program authorized by Title V of the Small Business 

Investment Act of 1958, commonly referred to as the “504 loan program” 

and overseen by the Small Business Administration (SBA).1 Certified 

development companies (CDC), which are nonprofit organizations that 

promote economic development in their communities, are certified by 

SBA to issue loans to small business borrowers under the 504 loan 

program.2 The program provides long-term, fixed-rate financing for longterm fixed assets, such as land and buildings, to new or growing small 

businesses.3 The goal of the program is to encourage economic 

development by providing small businesses with access to credit to 

enable them to create or retain jobs within their communities. As of 

November 30, 2013, there were approximately 270 CDCs, and SBA’s 504 

loan program portfolio included over 61,000 active loans with an 

outstanding balance of approximately $27.2 billion.

 

1

See 15 U.S.C. §§ 695-697g. 

2

SBA grandfathered for-profit CDCs existing as of January 1, 1987, into the program. 13 

C.F.R. § 120.820. There are six for-profit CDCs participating in the 504 loan program.

3

To qualify as a small business under the 504 loan program, a business and its affiliates 

must either meet the same size standards that apply to SBA 7(a) business loans set forth 

in 13 C.F.R. § 121.301(a) or must have a tangible net worth of $15 million or less and an 

average net income of $5 million or less after federal income taxes (excluding any 

carryover losses) for the preceding 2 completed fiscal years.
 

Page 2 GAO-14-233 504 Loan Program

GAO and the SBA Inspector General have previously reported on the 

need for SBA to strengthen oversight of its lenders.4 In recent oversight 

hearings, Congress emphasized the importance of improving the 

effectiveness and oversight of SBA programs and reducing costs.5 You 

requested that we review the 504 loan program. This report discusses (1) 

the lending standards and performance indicators that SBA has 

established to help ensure that loans meet key requirements, as well as 

504 loan program performance, (2) the extent to which SBA has 

implemented procedures to help ensure that CDCs are eligible to 

participate in the program and that loan applications comply with program 

requirements, and (3) the extent to which SBA has implemented 

procedures to monitor CDC compliance with program requirements.

To address these objectives, we reviewed relevant laws and regulations; 

GAO and SBA Inspector General reports; and SBA guidance, including 

Standard Operating Procedures (SOP). We also interviewed SBA staff 

and officials at 10 CDCs. We selected these CDCs to ensure a range of 

CDCs based on factors such as size and location. Due to ongoing 

litigation related to a subset of CDCs known as Premier Certified Lenders, 

we did not assess loans made using the specific additional authority that 

SBA may provide to these lenders.6

To respond to our first objective, we analyzed SBA 504 loan data for 

fiscal years 2003 through 2013 (as of Mar. 31, 2013) to determine the 

 

4

GAO, Small Business Administration: Actions Needed to Improve the Usefulness of the 

Agency’s Lender Risk Rating System, GAO-10-53 (Washington, D.C.: Nov. 6, 2009). SBA, 

Office of Inspector General, Addressing Performance Problems of High-Risk Lenders 

Remains a Challenge for the Small Business Administration, Report no. 12-20R 

(Washington, D.C.: Sept. 28, 2012).

5

See, e.g., Entrepreneurial Assistance: Examining Inefficiencies and Duplication Across 

Federal Programs: Hearing Before the H. Comm. on Small Business, 113th Cong. (2013) 

(statement of Rep. Sam Graves, Chairman, H. Comm. on Small Business); SBA’s 

Management of its Capital Access Programs: Hearing Before the H. Comm. on Small 

Business, 112th Cong. (2012) (statement of Rep. Sam Graves, Chairman, H. Comm. on 

Small Business).

6

See United States ex rel. U.S. Small Bus. Admin. v. EDF Res. Capital, Inc., No. 2:13-cv01158 (E.D. Cal.). The litigation is an enforcement action by SBA against EDF for, among 

other things, EDF’s alleged failure to pay amounts owed as a Premier Certified Lender to 

SBA. Under GAO’s policy to avoid addressing disputed factual or legal matters pending in 

litigation, we did not evaluate these matters, including the liquidation of defaulted loans, 

enforcement actions, or any loans made using Premier Certified Lender legal authority. 
 

Page 3 GAO-14-233 504 Loan Program

composition and performance of the current 504 loan portfolio.7 We 

assessed the reliability of the data by interviewing knowledgeable 

officials, reviewing documents about the sources of the data, and 

completing electronic testing. We determined that the data were 

sufficiently reliable for the purpose of reporting on portfolio composition 

and performance. We also assessed whether SBA’s performance 

measures were consistent with GAO standards for performance 

measurement.8 To address our second and third objectives, we reviewed 

SBA’s compliance processes, including its procedures for oversight of 

CDC eligibility and loan approval and for monitoring CDCs. We also 

reviewed SBA data and documentation on its compliance activities to 

determine the extent to which the agency had implemented these 

procedures and whether the procedures were consistent with internal 

control standards.9 Appendix I contains additional information on our 

scope and methodology.

We conducted this performance audit from January 2013 to March 2014 

in accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives.

As authorized by Congress, SBA established the 504 loan program to 

foster economic development; create or preserve job opportunities; and 

stimulate the growth, expansion, and modernization of small businesses. 

 

7

Data as of March 2013 were the most recent data available at the time of our request. 

The 504 data set we analyzed does not include any data on loans issued by CDCs using 

Premier Certified Lender Program authority or any non-Premier Certified Lender Program 

loans issued by the CDC with Premier Certified Lender Program authority that is involved 

in the pending litigation. The amount excluded totaled 9,233 loans and approximately $5.9 

billion. The data set provided by SBA included 80,080 loans totaling approximately $47 

billion. However, based on conversations with SBA officials, we limited the analysis to 

loans that had been disbursed—61,171 loans totaling about $34 billion.

8

GAO, Executive Guide: Effectively Implementing the Government Performance and 

Results Act, GAO/GGD-96-118 (Washington, D.C.: June 1996).

9

GAO, Standards for Internal Control in the Federal Government, GAO/AIMD-00-21.3.1

(Washington, D.C.: November 1999).

Background
 

Page 4 GAO-14-233 504 Loan Program

The 504 loan program provides long-term, fixed-rate financing to new or 

growing small businesses for fixed assets such as owner-occupied real 

estate or long-term equipment and machinery. Small businesses may 

apply for 504 financing through a CDC serving the area where the 504 

project is located. CDCs are generally nonprofit corporations that provide 

funding to small businesses in order to contribute to economic 

development within their communities.10 There are about 270 existing

CDCs located throughout the United States and Puerto Rico. A CDC 

must obtain certification from SBA to operate in a designated state; 

however, a few CDCs offer 504 funding in contiguous states contingent 

upon approval from SBA.11 The 504 loan program is intended to serve 

small businesses that might otherwise not have access to privately 

financed credit. Similar to other SBA loan guarantee programs, the 504 

program has a “credit elsewhere” requirement, which means that small 

business applicants must be unable to obtain credit on reasonable terms 

from a nonfederal source.12

In 1994, Congress authorized SBA to implement two programs to provide 

qualified CDCs with delegated authority to carry out certain functions 

associated with 504 loans that had previously been reserved for SBA.13

These two programs are the Accredited Lenders Program (ALP) and the 

Premier Certified Lenders Program. The two programs allow participating 

CDCs, in some cases, to unilaterally make decisions related to various 

loan activities. As discussed previously, the scope of this review does not 

include issues related to the Premier Certified Lenders Program. SBA 

 

10As previously mentioned, some for-profit CDCs were grandfathered in to the 504 loan 

program; however, all new CDCs must be nonprofit corporations. Additional criteria for 

CDC eligibility are provided by statute and regulation, and will be discussed in more detail 

later in this report. 

11CDCs operate within a defined area of operations covering a specific geographic area. 

The area of operations for a CDC must include the entire state in which it is incorporated. 

13 C.F.R. § 120.810(b).

12As part of the loan application process, the CDC must determine whether the small 

business applicant is unable to obtain a loan on reasonable terms without a federal 

government guarantee and that some or the entire loan is not available from the resources 

of the applicant or its business partners. To make this determination, the CDC applies 

SBA’s “credit elsewhere test,” which includes substantiating the factors that prevent the 

financing being undertaken without SBA support.

13See Pub. L. No. 103-403, tit. II, §§ 212, 217 (1994) (codified as amended at 15 U.S.C. 

§§ 697d, 697e).
 

Page 5 GAO-14-233 504 Loan Program

may designate a CDC as having ALP authority if the CDC meets certain 

statutory and regulatory requirements. The ALP designation is for 2 years 

and can be renewed. CDCs with ALP authority assume responsibility for 

thorough borrower credit and loan eligibility analysis on initial 504 loan 

applications, which we discuss in more detail later in this report.

For a typical 504 loan project, the financing is provided by three parties: a 

third-party lender, a CDC, and a small business borrower. A third-party 

lender, typically a commercial bank, provides financing totaling at least as 

much as the 504 loan, generally 50 percent or more of the total 504 

project financing. A CDC provides up to 40 percent of the financing 

through a loan (the “504 loan”) that is backed by a debenture that is fully 

guaranteed by SBA.14 The maximum amount a CDC can loan a small 

business borrower is $5,000,000 or $5,500,000, depending on the 

circumstances.15 Finally, the small business borrower must contribute at 

least 10 percent of the project financing. Exposure to default risk is tiered 

in the 504 loan program. The third-party lender’s loan is collateralized by 

a first lien on the project property. The CDC’s 504 loan is subordinate to 

the bank’s first position on the debt.

A 504 loan is approved but not funded by the sale of the debenture until 

project-related construction is completed. Prior to the sale of the 

debenture and funding of the 504 loan, the borrower may obtain interim 

financing from a third-party lender, usually the same lender that provided 

the loan covering 50 percent of the total 504 project financing. After 

project-related construction is completed, the 504 loan is closed, and the 

debenture is sold by SBA’s central servicing agent. The central servicing 

agent distributes the appropriate funds to the small business borrower on 

behalf of SBA and the CDC.

 

14SBA may authorize, for good cause shown, an increase in the 504 loan of up to 50 

percent of total project costs. A debenture is an obligation issued by a CDC and 

guaranteed 100 percent by SBA, the proceeds of which are used to fund a 504 loan. 

Debentures are packaged together and sold to underwriters. Investors then purchase 

interests in debenture pools.

15The lending limit for 504 loans issued by CDCs is $5,500,000 if the small business 

borrower is a small manufacturer, the project reduces the borrower’s energy consumption 

by at least 10 percent, or the project generates renewable energy or renewable fuels. For 

all other 504 loans, the lending limit is $5,000,000. 
 

Page 6 GAO-14-233 504 Loan Program

SBA’s Office of Capital Access (OCA) is responsible for overseeing the 

504 loan program and CDCs. The Office of Financial Assistance (OFA) is 

an office within OCA that is responsible for the implementation of the 504 

loan program. OFA’s primary responsibilities include structuring the 504 

loan application process and making necessary adjustments to 

application criteria based on feedback from program participants and data 

analysis. OFA also monitors and oversees the requirements and program 

protocols that determine SBA’s ability to extend capital to small 

businesses. The Office of Performance and Systems Management, also 

within OCA, analyzes relevant data to inform final 504 policy decisions 

and provides system oversight for the central servicing agent, among 

other responsibilities. The Office of Credit Risk Management (OCRM), 

another office within OCA, is responsible for managing all activities 

regarding lender and CDC oversight. Its duties include assigning risk 

ratings to CDCs, conducting reviews, and preparing written reports 

addressing CDC oversight. Finally, OCA’s Office of Financial Program 

Operations is responsible for the execution of the 504 program through 

loan processing and servicing and through liquidation of 504 loans and 

management of the loan portfolio.

SBA also has district offices and processing and servicing centers that 

have a role in the 504 program. Staff in SBA’s 68 district offices provide 

local assistance to participating CDCs and occasionally offer 504 program 

training courses to lenders and CDCs. They also conduct annual reviews 

of CDCs’ annual reports. In addition, district office counsel review 504 

loan closing documentation, among other things. The Sacramento Loan 

Processing Center (SLPC) evaluates and issues loan guarantee 

commitments to eligible and creditworthy 504 loan applicants. In addition, 

there are two servicing centers, located in Little Rock, Arkansas, and 

Fresno, California, that serve CDCs based on the CDC’s location. These 

two servicing centers collectively handle the entirety of SBA’s commercial 

loan servicing activities, including the liquidation of 504 loans. The Office 

of Financial Program Operations is responsible for managing SLPC and 

the two servicing centers.
 

Page 7 GAO-14-233 504 Loan Program

We analyzed 504 loan program data for fiscal years 2003 through 2013 

(as of Mar. 31, 2013) to identify loans approved and disbursed.16 Based 

on our analysis of this subset of loans, SBA approved loans totaling the 

largest amounts in fiscal years 2006 and 2007 (see fig. 1). In fiscal years 

2008 and 2009, the total number of 504 loans approved and disbursed 

declined slightly. Section 504 of the American Recovery and 

Reinvestment Act of 2009 and Section 1122 of the Small Business Jobs 

Act of 2010 (Jobs Act) expanded the 504 program to allow debt 

refinancing under certain circumstances, which could account for some of 

the increase after 2009.17 The temporary debt refinancing program 

authorized by the Jobs Act expired at the end of fiscal year 2012.

 

16As noted previously, we limited our analysis of data provided by SBA to loans that had 

been approved as of March 2013 and disbursed. We did this to facilitate our analysis of 

default rates, which is presented later in this report. SBA officials noted that, based solely 

on the total number of loans approved, fiscal year 2012 had the most loans approved of all 

the years, not fiscal year 2007. SBA officials also stated that due to the time lag between 

approval and disbursement (which can be up to 4 years, but is usually 1 to 2 years) the 

number of loans approved in fiscal years 2011 and 2012 and disbursed will continue to 

increase as more loans are disbursed.

17American Recovery and Reinvestment Act of 2009, Pub. L. No. 111-5, § 504, 123 Stat. 

115, 155 (2009); Small Business Jobs Act of 2010, Pub. L. No. 111-240, § 1122, 124 Stat. 

2504, 2510 (2010).
 

Page 8 GAO-14-233 504 Loan Program

Figure 1: Number and Dollar Amount of 504 Loans Approved and Disbursed, Fiscal 

Years 2003-2012

Note: The SBA data we analyzed were as of March 31, 2013. Our analysis excluded loans that were 

(1) approved in fiscal years 2003 through 2012 but not disbursed as of March 2013 and (2) made 

using Premier Certified Lender Program authority. SBA officials stated that due to the time lag

between approval and disbursement (which can be up to 4 years, but is usually 1 to 2 years) the 

number of loans approved in fiscal years 2011 and 2012 and disbursed will continue to increase as 

more loans are disbursed.

Based on our analysis, the top four types of small businesses funded by 

504 loans were hotels, restaurants, doctors’ offices, and dentists’ offices. 

Respectively, these business types made up 12 percent, 5 percent, 4 

percent, and 3 percent of all approved 504 loan dollars from fiscal year 

2003 through 2012. Also, 85 percent of approved loans and dollars went 

to existing small businesses, and 15 percent went to new small 

businesses.
 

Page 9 GAO-14-233 504 Loan Program

SBA has established lending standards and guidance that address 

program requirements and protect against default risk. However, the 

agency has not provided CDCs with specific guidance on compiling and 

supporting data on jobs created or retained as a result of 504 loans, 

which is a key economic development goal of the 504 loan program. SBA 

also has established performance indicators for the 504 program and 

analyzed 504 program data to measure loan performance.

SBA has established lending standards and guidance for CDCs that 

address 504 program requirements and protect against default risk. Table 

1 contains some of the key requirements of the 504 program.

Table 1: Selected Requirements of the 504 Loan Program

Requirement Description

Economic development goals A project must create or retain one job for every $65,000 guaranteed by SBA (one job 

for every $100,000 for projects assisting small manufacturers), or, if the CDC’s overall 

loan portfolio has already met the jobs creation and retention requirement,

• the project must improve the economy of the locality, such as by stimulating other 

business development in the community, bringing new income into the area, or 

assisting the community in diversifying and stabilizing its economy, or

• the project must meet one of other enumerated public policy goals.a

Lending limits The 504 lending limit is $5,000,000-$5,500,000 per loan, depending on the type of 

project being funded by the loan, and a 504 loan generally may not exceed 40 percent 

of the project’s cost (and in certain cases, for good cause shown, up to 50 percent).

Funding portion from the small business 

borrower

The borrower funds 15% of the project cost if the small business has been in operation 

2 years or less or if the project involves the construction of a limited- or single-purpose 

building or structure; 20% if both above conditions apply; and 10% in all other 

circumstances, at the discretion of the CDC.

Third-party lender financing A third-party lender must contribute not less than 50 percent of total project costs if the 

borrower has operated for 2 years or less or if the project is for the acquisition, 

construction, conversion, or expansion of a limited- or single-purpose asset. For all 

loans, the third-party loan must total at least as much as the 504 loan.

SBA Has Established 

Lending Standards 

and Measured 

Performance, but 

Lacks Guidance on 

Determining Jobs 

Supported

SBA Lending Standards 

Address 504 

Requirements and Default 

Risk, but SBA Lacks 

Guidance on Determining 

Jobs Supported
 

Page 10 GAO-14-233 504 Loan Program

Requirement Description

Collateral The CDC usually takes a second lien position on the project property to secure the 504 

loan. Additional collateral shall be required only if SBA determines, on a case-by-case 

basis, that additional security is necessary to protect the interest of the government.

Source: 15 U.S.C. §§ 695-697g; 13 C.F.R. pt. 120.

a

The public policy goals for the 504 loan program are business district revitalization; expansion of 

exports; expansion of minority business development or women-owned business development; rural 

development; expansion of small business concerns owned and controlled by veterans; enhanced 

economic competition; changes necessitated by federal budget cutbacks; business restructuring 

arising from federally mandated standards or policies affecting the environment or the safety and 

health of employees; reduction of energy consumption by at least 10 percent; increased use of 

sustainable design; plant, equipment, or process upgrades of renewable energy sources; and 

reduction of rates of unemployed in labor surplus areas.

SBA has issued regulations implementing the program as well as SOPs 

that address program requirements and provide additional guidance to 

CDCs on how to implement the program.18 SOP 50 10 Subpart C 

addresses the 504 loan program. In addition to the noneconomic 

development-related requirements listed in table 1, SBA officials said that 

credit underwriting standards and reviews of borrowers’ character and 

credit history, required by regulation and discussed in the SOP, are 

important requirements that protect against default risk. The SOP lays out 

the credit underwriting standards that CDCs must comply with as part of 

the 504 loan approval process. It specifies that CDCs must analyze each 

loan application in a manner consistent with prudent lending standards 

and that the cash flow of the small business is the primary source of 

repayment. In addition, the SOP discusses the types of financial analyses 

CDCs must perform as part of determining the viability of the project. SBA 

officials added that the third-party lender also performs its own credit 

underwriting of the 504 project, which provides additional review of the 

project and also helps protect against default risk. The majority of CDCs 

(7 of 10) we spoke with thought SBA 504 lending standards were 

sufficient in addressing default risk.19 Three of the 10 CDCs noted that it 

is the CDC’s responsibility to make sure it is underwriting good loans. 

SBA also requires reviews of borrowers’ character and credit history. 

Specifically, SBA requires that any person with 20 percent or more 

 

1813 C.F.R. pt. 120; U.S. Small Business Administration Office of Financial Assistance, 

SOP 50 10 5 (F): Lender and Development Company Loan Programs (Jan. 1, 2014); and 

U.S. Small Business Administration Office of Capital Access, SOP 50 55: 504 Loan 

Servicing and Liquidation (Oct. 1, 2013).

19Two of the 10 CDCs we spoke with did not directly comment on the sufficiency of SBA’s 

lending standards to protect against default risk, and one CDC commented that they 

thought SBA’s standards were too broad.
 

Page 11 GAO-14-233 504 Loan Program

ownership interest in the small business applying for the loan be of good 

character.20

SBA officials said that they consider the 504 financing structure to be 

another protection against default risk. As previously discussed, 504 loan 

applications are initially approved but are not funded until after projectrelated construction has been completed (see fig. 2). A third-party 

lender—typically, the bank that provides 50 percent of the 504 project 

cost—provides interim financing to cover the 504 loan portion of the 

project (typically 40 percent) prior to construction being completed. As no 

SBA-guaranteed funds are disbursed until key aspects of the project have 

been completed, this mitigates the risk of default due to problems with 

construction or other issues that may arise prior to project completion. 

SBA officials told us that the time between approval and closing varies 

depending on the extent of construction. The debenture must be sold to 

fund the 504 loan within at least 4 years of the initial approval of the 504 

loan. After the project is completed, the 504 loan is closed in accordance 

with SBA processes (discussed later in this report) and the debenture is 

sold. SBA officials told us that it is rare for loans that were initially 

approved not to eventually be funded by the sale of a debenture. 

However, as discussed previously, the third-party lender typically holds a 

first-lien position on collateral provided under the 504 loan financing 

agreement, exposing SBA to potentially higher losses in the event of a 

default.

 

20These individuals are required to complete a Statement of Personal History (SBA Form 

912), which includes questions on criminal history.
 

Page 12 GAO-14-233 504 Loan Program

Figure 2: Typical 504 Project Structure

Note: As discussed previously, in certain cases the small business borrower must contribute more 

than 10 percent. For example, a business that has been in operation less than 2 years must 

contribute 15 percent of total project costs.

SBA’s commercial loan servicing centers review and approve certain 

servicing actions that are not delegated to CDCs. For all CDCs, SBA 

must approve certain servicing requests, such as exceptions to policy, 

compromise of the principal loan balance, increase in a loan amount, 

litigation plans, acquisition of title to any property in SBA’s name, or any 

other loan action for which SBA’s prior written consent is required by 

another loan program requirement.21 For regular CDCs and CDCs with 

ALP authority, SBA must approve servicing requests such as liquidation 

plans, substantial alterations of the terms or conditions of any loan 

document, and the compromise of any portion of the loan balance.22

Otherwise, regular and ALP CDCs generally have unilateral authority 

(meaning they can take action without prior SBA approval) to take all 

 

21SOP 50 55, Chapter 3, Para.D.3.a. (effective date Oct. 1, 2013) contains a list of 

servicing requests that SBA must approve for all CDCs.

22SOP 50 55, Chapter 3, Para. D.3.b. (effective date Oct. 1, 2013) contains a list of 

servicing requests that SBA must approve for regular CDCs and CDCs with ALP authority.
 

Page 13 GAO-14-233 504 Loan Program

necessary action to service and liquidate the 504 loans for which they are 

responsible, subject to SBA’s right to take over the servicing or liquidation 

of any loan.23 CDCs must provide the appropriate commercial loan 

servicing center with written notice of each substantive unilateral loan 

action taken on a 504 loan.24 SBA’s central servicing agent collects loan 

payments and reports delinquencies on its secure website.25 However, 

CDCs are responsible for pulling reports and reporting 60-day 

delinquencies to SBA. SBA can also pull reports for the 504 program from 

the central servicing agent’s website. In October 2013, SBA created SOP 

50 55, which consolidated servicing and liquidation guidance specific to 

the 504 loan program. SBA officials told us that they did this in order to 

make the 504 servicing guidance more user-friendly.

While SBA guidance addresses many of the program’s key requirements 

and default risk, SBA has not provided specific guidance to CDCs on how 

to compile and support data they report on jobs created or retained due to 

504 lending. When applicable, SOP 50 10 requires that CDCs provide an 

estimate of jobs to be created or retained in the loan application and 

update the estimate 2 years after a loan is disbursed.26 The SOP also 

states that a job opportunity does not have to be at the project facility, but 

75 percent of the jobs must be in the community where the project is 

located. In addition, it states that job retention may be used if the CDC 

can reasonably show how jobs would be lost to the community if the 

project was not done. However, the SOP does not provide any explicit 

guidance on which jobs within the community may count towards jobs 

supported, nor does it explain how CDCs should reasonably show that 

jobs would be lost without a 504-supported project.27 The SOP also does 

not discuss the types of supporting documentation that CDCs should 

collect as part of compiling jobs supported information. In the past, we 

 

23SOP 50 55, Chapter 3, Para. D.1. (effective date Oct. 1, 2013).

24SOP 50 55, Chapter 3, Para. D.2. (effective date Oct. 1, 2013).

25The central servicing agent receives and disburses funds among the various parties 

involved with 504 loan financing under a master servicing agent agreement with SBA.

26As noted previously, if the CDC’s overall loan portfolio meets the jobs requirement, the 

CDC can approve projects that meet other economic development goals.

27SBA provides additional guidance on calculating jobs created and retained in its 504 

loan application (Form 1244) and CDC Annual Report Guide (Form 1253), but this 

guidance is less specific than that in the SOP.
 

Page 14 GAO-14-233 504 Loan Program

have commented that reporting on jobs created and retained can be 

problematic without clear guidance.28 Federal internal control standards 

emphasize the need for federal agencies to have control activities in 

place to help ensure that program participants report information 

accurately.29 Control activities are policies, procedures, and methods 

(such as guidance) that enforce management directives. Without clear 

and specific guidance on compiling jobs supported data, SBA cannot 

ensure that CDCs are compiling and supporting this information 

consistently and in accordance with SBA’s expectations.

SBA has established indicators to track program performance, including a 

measure to track a key economic development requirement (number of 

jobs created or retained). As shown in table 2, these indicators are loans 

approved, small businesses assisted, small businesses assisted in 

underserved markets, jobs supported, active lending partners, cost per 

small business assisted, and approved applications originated 

electronically.30 SBA’s indicators are consistent with our standards, which 

 

28We found weaknesses in recipient reporting on jobs created and retained during our 

work on the American Recovery and Reinvestment Act. For example, in November 2009 

we reported data inconsistencies and recommended, among other things, that the Office 

of Management and Budget (1) clarify the definition and standardize the period of 

measurement for full-time equivalents and (2) consider being more explicit that “jobs 

created or retained” are to be reported as hours worked and paid for with Recovery Act 

funds. See GAO, Recovery Act: Recipient Reported Jobs Data Provide Some Insight into 

Use of Recovery Act Funding, but Data Quality and Reporting Issues Need Attention,

GAO-10-223 (Washington, D.C.: Nov. 19, 2009); Recovery Act: One Year Later, States’ 

and Localities’ Uses of Funds and Opportunities to Strengthen Accountability,

GAO-10-437 (Washington, D.C.: Mar. 3, 2010); and Recovery Act: States’ and Localities’ 

Uses of Funds and Actions Needed to Address Implementation Challenges and Bolster 

Accountability, GAO-10-604 (Washington, D.C.: May 26, 2010). 

29GAO/AIMD-00-21.3.1.

30SBA defines underserved markets as underserved populations and underserved places. 

Underserved populations include veteran-owned, women-owned, and minority-owned 

small businesses. Underserved places include small businesses that are located within 

geographic areas listed as Historically Underutilized Business Zones (HUBZone), low- and 

moderate-income areas, and Empowerment Zones and Enterprise Communities. 

HUBZone is a federal program that helps small businesses in urban and rural 

communities gain preferential access to federal procurement opportunities. Low- and 

moderate-income areas are determined by the Department of Housing and Urban 

Development based on census data. The Empowerment Zones and Enterprise 

Communities program encourages comprehensive planning and investment aimed at the 

economic, physical, and social development of the neediest urban and rural areas in the 

United States.

SBA Has Established 

Indicators to Measure 

Program Performance
 

Page 15 GAO-14-233 504 Loan Program

recommend the establishment of performance measures that include key 

output measures as well as cost information, such as the unit cost per 

output.31 In fiscal year 2012, SBA met or exceeded its targets for six of its 

seven performance indicators, which is an improvement from fiscal year 

2011, during which SBA met only one of its targets.

Table 2: Performance Indicators for the 504 Loan Program, Fiscal Years 2010-2012

Performance 

indicator

Type of 

indicator 2010 target 2010 actual 2011 target 2011 actual 2012 target 2012 actual 

Loans 

approved ($)

Output $4,000,100,000 $4,433,308,000 $4,750,000,000 $4,845,119,000 $4,100,000,000 $6,711,656,000

Number of 

small 

businesses 

assisted

Output 5,600 7,664 8,100 7,752 6,800 9,038

Number of 

small 

businesses 

assisted in 

underserved 

markets

Output 3,500 4,384 4,800 4,548 4,000 5,379

Number of 

jobs 

supported

Outcome 133,000 82,543 88,800 87,337 75,900 116,569

Number of 

active lending 

partners

Output 267 267 267 249 267 256

Cost per 

small 

business 

assisted ($)

Efficiency $15,191 $4,728 $4,979 $5,017 $5,839 $4,383

Approved 

applications 

originated 

electronically 

(%) 

Efficiency N/Aa N/Aa N/Aa 50% 62% 65%

Source: SBA’s FY 2010, FY 2011, and FY 2012 Annual Performance Reports.

Note: Numbers in bold indicate targets not met.

a

SBA first introduced this performance indicator in fiscal year 2011 and began setting targets for this 

indicator in fiscal year 2012.

 

31GAO/GGD-96-118. Outputs represent the quantity of goods or services produced by a 

program. Inputs are the amount of resources (in terms of money, material, personnel, etc.) 

that are put into a program.
 

Page 16 GAO-14-233 504 Loan Program

In most cases, SBA has a process in place to collect and validate the 

data used to report on its performance indicators. Data for several 

indicators—loans approved, small businesses assisted, and active 

lending partners—are captured using SBA’s loan application and 

accounting systems. With respect to the underserved markets indicator, 

there are two components. Data on underserved populations are 

captured in SBA’s loan application and accounting systems. Loans are 

also geographically coded based on their business address in SBA’s loan 

accounting system, from which SBA can determine if the borrower’s 

project is in an underserved place. According to SBA, both its loan 

application and loan accounting systems are subject to periodic audits of 

their completeness and accuracy, and these audits provide validation of 

the collected data. According to SBA officials, the agency uses a separate 

technique for calculating the cost per small business assisted by 

compiling employee-reported information from annual activity surveys on 

which SBA staff indicate what portion of their overall time is spent working 

on the 504 program. SBA officials stated that supervisors review each 

survey for accuracy and completeness prior to submission. SBA validates 

the percentage of applications originated electronically by verifying that 

the information in its data sets coincides with what is shown in the loan 

application system and other data from its loan processing centers.

However, SBA does not have a process for validating the jobs supported 

indicator, which is based on data reported by CDCs. According to SBA 

guidance, CDCs are to estimate the number of jobs supported at the time 

of the loan application and determine the actual number 2 years after a 

504 loan is disbursed, as previously discussed. When compiling data for 

this indicator, SBA states that it uses the data captured in SBA’s loan 

application system at the time of loan approval. SBA officials who are 

responsible for reporting on the performance indicators have stated that 

no process currently exists for reviewing jobs supported information that 

SBA receives from CDCs. SBA’s lack of a process for reviewing jobs 

supported information received from CDCs will be discussed in greater 

detail later in this report.
 

Page 17 GAO-14-233 504 Loan Program

SBA staff analyze 504 loan data on a weekly, monthly, quarterly, and 

annual basis and prepare reports at each of these intervals. These 

reports analyze various aspects of 504 program performance, including 

loan activity (amount of dollars approved), loan status (current, stressed, 

delinquent), and cash flows.32 SBA officials said that they have been 

issuing these reports in some form since 2002 and that senior 

management, including the Assistant Administrator and managers in OFA 

and OCRM, review these reports. They noted that the purposes of these 

reports include aiding senior officials in tracking program performance 

and identifying potential issues that may have an impact upon the 

program’s performance. For example, a report may show a decrease in 

504 loan applications, which may indicate a need for increased education 

about the 504 loan program to the small business community. SBA 

officials will then be able to determine whether or not to further promote 

the program to the lending community. SBA officials also noted that these 

reports have helped OCRM make changes to its lender oversight policies. 

For example, based on their reviews of some of these reports, OCRM has 

begun to stratify and compartmentalize its measurement of lenders’ 

compliance based on delegated authority (ALP or regular), risk, and size.

We analyzed SBA data on 504 loans approved from fiscal year 2003 

through fiscal year 2013 (as of Mar. 31, 2013) and found that 504 loans 

followed trends in the U.S. economy.33 Of the loans we analyzed, 10.8 

percent were paid in full, 72.9 percent were current, 4.0 percent were 

stressed, and 12.3 percent had their debentures purchased (i.e., 

defaulted loans). As seen in figure 3, 504 loans (loans issued by CDCs 

and backed by SBA’s 100 percent guarantee) approved during the 

economic expansion period from 2005 through 2007 experienced higher 

default rates than any other year during the period from 2003 through 

2012. Specifically, 504 loans approved from fiscal year 2005 through 

fiscal year 2007 had the highest default rates, and loans approved from 

fiscal year 2006 through fiscal year 2008 had the highest 18-month 

 

32SBA defines stressed loans as any loans in deferred, past due, delinquent, or catch-up 

status. SBA defines delinquent loans as loans that are 60 or more days past due. 

33We analyzed loan-level data from SBA on 504 loans—those issued by CDCs and 

backed by SBA’s 100 percent guarantee. This analysis does not include the third-party 

lender portion of a 504 project’s financing.

SBA Analyzes Program 

Performance, and Default 

Rates Have Followed U.S. 

Economic Trends
 

Page 18 GAO-14-233 504 Loan Program

default rates.34 The default rate (the number of 504 loans whose 

debentures were purchased divided by the total loans approved in that 

fiscal year) for loans approved in fiscal year 2006 was 24.0 percent, the 

highest default rate for the observed period. Loans approved in fiscal year 

2007 experienced the highest 18-month default rate at 4.9 percent. 

According to SBA officials, the 18-month default rate is an indicator of 

default primarily due to poor underwriting.

Figure 3: Default Rates by Cohort Year (Year 504 Loan Approved), Fiscal Years 

2003-2012

Note: The SBA data we analyzed were as of March 31, 2013. Our analysis excluded loans that were 

(1) approved in fiscal years 2003 through 2012 but not disbursed as of March 2013 and (2) made 

 

34In our analysis, we determined that a 504 loan had defaulted if SBA had purchased the 

loan’s associated debenture. SBA guidance states that a good faith effort should be made 

to help delinquent borrowers bring their loans current. But, when a payment default cannot 

be cured, the loan should be classified as in liquidation and the CDC should immediately 

request that SBA purchase the loan’s associated debenture. The default rate is the total 

number of loans that had defaulted divided by the total number of loans approved in a 

given fiscal year. The 18-month default rate is the number of loans that defaulted within 18 

months of disbursal divided by the total number of loans approved in a given fiscal year. 
 

Page 19 GAO-14-233 504 Loan Program

using Premier Certified Lender Program authority. The default rate is the total number of loans that 

had defaulted divided by the total number of loans approved in a given fiscal year. The 18-month 

default rate is the number of loans that defaulted within 18 months of disbursal divided by the total 

number of loans approved in a given fiscal year.

The 504 default rates followed trends in the U.S. economy during this 

period. A study on the U.S. financial crisis stated that the crisis was 

triggered by a dramatic weakening of underwriting for U.S. subprime 

mortgages, beginning in late 2004 and extending into early 2007, which 

was “symptomatic of a much broader erosion of market discipline on the

standards and terms of loans to households and businesses.”

35 Further, 

SBA officials told us that the 504 loan program—which primarily finances 

commercial real estate—was negatively impacted by declining 

commercial real estate values beginning in 2008. According to data from 

Moody’s/REAL Commercial Property Price Index for 2002 through 2010, 

commercial real estate values increased by more than 85 percent from 

2002 to the market’s peak in October 2007, at which point these values 

steadily declined, leveling off around 2010. SBA officials noted that this 

rapid decline in real estate prices was associated with increased 504 loan 

defaults. Declining prices can make refinancing difficult for borrowers and 

thus lead to a higher rate of commercial real estate loan defaults. 

However, because this period also overlapped with a general economic 

recession, some of the defaults may have also been due to a lack of 

general business revenue.

We compared 504 loan data to the Federal Deposit Insurance 

Corporation’s quarterly analysis of Federal Financial Institutions 

Examination Council call report data on the performance of loans issued 

by U.S.-chartered commercial banks and found similar patterns.36 We 

analyzed call report data on construction and development loans and real 

estate loans (“commercial loans”). As shown in figure 4, the percentage of 

defaulted 504 loans that were disbursed within the 2 previous years and 

the nonaccrual rates for commercial loans both peaked in the first quarter 

of 2010. (Loans in nonaccrual status are nonperforming loans on which 

 

35President’s Working Group on Financial Markets, Policy Statement on Financial Market 

Developments (March 2008). 

36A “call report” is a report that must be filed by all insured depository institutions in the 

United States on a quarterly basis and contains financial information about the institutions. 

The report is officially known as the Report of Condition and Income.
 

Page 20 GAO-14-233 504 Loan Program

payments are at least 90 days overdue.37 We used nonaccrual status as a 

trend comparison because it was the weakest category of loans and most 

similar to purchases made by SBA. However, while trends may be 

compared, levels of nonaccrual rates and SBA default rates may not be 

compared, as SBA data represent early defaults only and the call report 

data represent nonaccruals for total outstanding loans.) Since then, both 

of these rates have experienced steady declines.

Figure 4: Comparison of Trends in Nonaccrual Rates for 504 Loans and Private Sector Commercial Loans, Calendar Years 

2004-2013

Note: The SBA data we analyzed were as of March 31, 2013. Our analysis excluded loans that were 

(1) approved in fiscal years 2005 through 2013 (as of Mar. 31, 2013) but not disbursed as of March 

2013 and (2) made using Premier Certified Lender Program authority. While trends may be 

compared, levels of nonaccrual rates may not be compared to SBA default rates because SBA data 

represent early defaults only and the call report data represent nonaccruals for total outstanding 

loans. This figure shows the value of the three rates over time, expressed as a percentage of that rate 

in the fourth quarter of 2004. For example, the nonaccrual rate for construction loans was 0.40 

percent in the fourth quarter of 2004. At its peak in the first quarter of 2010, it was 15 percent. 

 

37We calculated the nonaccrual rate for commercial loans as the percentage of loan 

dollars in nonaccrual status (principal or interest has been in default for at least 90 days, 

and payment in full is not expected) out of the total amount of outstanding loan dollars for 

the quarter of that calendar year. In order to compare 504 loan data with this rate, we 

calculated the percentage of defaulted 504 loans that were disbursed within the past 2 

years for each quarter of the calendar. 
 

Page 21 GAO-14-233 504 Loan Program

Therefore, for the fourth quarter of 2004 the index has a value of 100 percent and for the first quarter 

of 2010 the index has a value of 3,500 percent, which is 37 times its original value.

We also compared the performance of different types of 504 loans 

approved in fiscal years 2003 through fiscal year 2013 (as of Mar. 31, 

2013). Certain aspects of the 504 program performed better than others 

with respect to defaults. ALP loans, for example, had a default rate of 

11.0 percent, compared to a default rate of 14.9 percent for regular 504 

loans. Further, the 18-month default rate for regular 504 loans was 2.5 

percent, while the same rate for ALP loans was lower at 1.6 percent. We 

also compared default rates for 504 loans made to new small business 

borrowers versus those made to existing small businesses. We found that 

existing small businesses experienced a default rate of 10.9 percent and 

a 1.6 percent 18-month default rate, while new businesses experienced a 

higher default rate of 19.8 percent and a 4.0 percent 18-month default 

rate.

In addition, we analyzed 504 loan performance based on the location of 

the CDCs making the loans. Figure 5 illustrates default rates and 18-

month default rates by state.38 Mississippi, Puerto Rico, Nevada, West 

Virginia, Arizona, and Florida had the highest rates of total defaulted 

loans. Puerto Rico, Alabama, Maine, Kentucky, West Virginia, and Florida 

had the highest 18-month default rates.

 

38This analysis covers all states with CDCs, the District of Columbia, and Puerto Rico. 

(There is no CDC located in Alaska.)
 

Page 22 GAO-14-233 504 Loan Program

Figure 5: Default Rates by State, as of March 2013

Note: The SBA data we analyzed were as of March 31, 2013. Our analysis excluded loans that were 

(1) approved in fiscal years 2003 through 2013 (as of Mar. 31, 2013) but not disbursed as of March 

2013 and (2) made using Premier Certified Lender Program authority. We analyzed 504 loan 

performance based on the state in which the CDC was located. All 50 states (except Alaska), the 

District of Columbia, and Puerto Rico had CDCs.

According to SBA analysis, 504 loan program cash flows have 

consistently been negative since 2008. In fiscal year 2012, SBA 

purchased $871.9 million in defaulted 504 loan debentures, resulting in 

an overall net cash flow of negative $555.3 million for the year. Costs of 

504 loan defaults are offset by collected fees and any recoveries.39 Net 

cash flow is equal to the sum of all fees and recoveries minus purchases. 

In fiscal year 2011, SBA purchased $1.3 billion in defaulted 504 loan 

debentures, and the program had a negative cash flow of $1.1 billion. In 

fiscal year 2010, the program experienced an even greater negative cash 

flow with a deficit of $1.4 billion after purchasing $1.6 billion in defaulted 

504 loan debentures that fiscal year. According to SBA, the effects of the 

economic recession and the 504 loan program fee reductions that went 

into place under the American Recovery and Reinvestment Act and the 

 

39SBA is authorized to assess and collect certain fees, such as loan origination and 

servicing fees, and is authorized to use the proceeds of such fees to offset the cost of 

making guarantees in the 504 loan program. 15 U.S.C. § 697(b)(7). 
 

Page 23 GAO-14-233 504 Loan Program

Small Business Jobs Act of 2010 played a large role in the substantial 

cash flow deficit for fiscal years 2010 through 2012.40

From fiscal year 2008 through fiscal year 2013 (as of April 2013), SBA 

charged off 6,888 504 loans for a total of $3.4 billion in charged-off 

dollars. Charged-off dollars are the remaining balance of the loan, after all 

recoveries (the amount of funding recovered from defaulted loans) are 

made, that SBA charges off its balance sheet. During this period, SBA 

recovered $353.5 million from defaulted loans and calculated a recovery 

rate of 9.3 percent. SBA officials stated that the 504 loan program has a 

low recovery rate due in part to the fact that the third-party lenders (which 

generally provide at least 50 percent of the financing on the 504 project) 

typically have the first lien on the assets funded by the 504 loan and 

receive any recoveries before SBA. SBA’s guarantee of the debenture 

lessens the risk exposure associated with bank lending compared with a 

conventional commercial loan; SBA’s second lien position further 

transfers risk to SBA.41 By taking on this risk, SBA’s guarantee and lien 

position can facilitate lending and economic development that may not 

occur otherwise.

SBA has processes to review CDCs’ eligibility to participate in the 504 

loan program but, as previously mentioned, does not require or examine 

support for CDC-reported data on jobs created or retained. SBA also 

does not require SBA staff to review CDC compliance with the retainedearnings requirement when reviewing CDC eligibility. SBA has multiple 

processes for reviewing 504 loan applications; however, SBA does not 

verify certifications made by CDCs with ALP authority at loan closing that 

the small business borrower has not suffered any adverse financial 

changes since the 504 loan was initially approved.

 

40American Recovery and Reinvestment Act of 2009, Pub. L. No. 111-5, 123 Stat. 115 

(2009); Small Business Jobs Act of 2010, Pub. L. No. 111-240, 124 Stat. 2504 (2010).

41We define a conventional commercial loan as financing of fixed assets without an SBA 

guarantee. Due to data limitations and differences in loan structure, we were not able to 

compare the recovery rates for 504 loans to those of conventional commercial loans. 

SBA Reviews CDC 

Eligibility and Loan 

Applications, but 

Does Not Confirm 

Compliance with 

Some Requirements
 

Page 24 GAO-14-233 504 Loan Program

SBA has established a process for approving CDCs to participate in the

504 loan program, which includes a probationary period. Institutions that 

are interested in participating in the 504 loan program must first apply and 

receive approval from SBA to become a CDC. To be eligible, an 

institution must, among other things, (1) be a nonprofit corporation, (2) be 

in good standing with, and in compliance with all laws in, the state in 

which the CDC is incorporated and in any other state in which the CDC 

conducts business, and (3) have at least 25 members who actively 

support economic development in the proposed area of operations.42 A 

CDC applicant must apply to the SBA district office serving the applicant’s 

proposed area of operations for certification. The applicant is required to 

submit several documents, including evidence of its nonprofit status and 

an operating budget. District office staff make their recommendation and 

send the application to headquarters for final approval. If their initial 

application is approved, CDCs are then on probation for 2 years, meaning 

they do not yet have permanent status as a CDC. At the end of the 2-year 

probation, the CDC must petition SBA for permanent CDC status or a 

year-long extension of probation.43 SBA will decide whether to give a 

CDC permanent status based, in part, on comments received from the 

applicable servicing center, the CDC’s compliance with 504 requirements, 

and the performance of the CDC’s 504 loan portfolio.44

SBA annually reviews current CDCs’ continuing eligibility to participate in 

the 504 loan program. A CDC must submit an annual report to its SBA 

district office within 180 days after the end of its fiscal year and include 

audited or reviewed financial statements, as applicable, and such interim 

 

42Members must be from one of the following groups: (1) government organizations 

responsible for economic development, (2) financial institutions that provide commercial 

long-term fixed-asset financing (lenders), (3) community organizations dedicated to 

economic development (e.g., chambers of commerce, foundations, colleges), and (4) 

businesses located within the CDC’s area of operations. 

43SBA considers failure to file a petition before the end of the probationary period as a 

withdrawal from the 504 program. If a CDC elects to withdraw, it must transfer all funded 

and approved loans to another CDC, SBA, or another servicer approved by SBA.

44According to SBA regulations, the CDC must have satisfactory performance, as 

determined by SBA. The CDC’s risk rating will be considered in determining satisfactory 

performance. Other factors considered may include examination assessments, historical 

performance measures (e.g., default rate, purchase rate, and loss rate), and loan volume 

(to the extent it impacts performance measures). 13 C.F.R. § 120.812(c).

SBA Reviews CDC 

Eligibility, but Does Not 

Confirm Compliance with 

Jobs-Supported and 

Retained-Earnings 

Requirements
 

Page 25 GAO-14-233 504 Loan Program

reports as SBA may require.45 In its annual report, a CDC must also 

indicate the job opportunities actually or estimated to be provided by each 

project. In addition to an annual report, CDCs must also submit to SBA a 

statement of personal history for each new associate and staff, reports of 

involvement in any legal proceedings, changes in organizational status, 

changes in any condition that affects its eligibility to continue to participate 

in the 504 program, quarterly service reports on each loan in its portfolio 

which is 60 days or more past due, and other reports as required by SBA. 

District office staff use an annual report review template to review CDCs’ 

annual reports before forwarding the reports to SBA staff in headquarters. 

The CDC annual report review template covers the CDCs’ 504 activity 

(e.g., number of loans approved and closed and delinquencies), 

organization (e.g., staff changes), and financial capacity (e.g., 

consistency in revenues and expenses). SBA officials stated that they use 

a monthly management report to track the status of CDCs’ annual report 

submissions.

The annual report review template does not require SBA staff to confirm 

CDC compliance with certain key 504 requirements. For example, while 

the template requires SBA staff to review the number of jobs created or 

retained included in the annual report, it does not require staff to request 

and review supporting documentation for the figures reported. As 

discussed previously, each CDC is required to create or retain one job in 

its community for every $65,000 of 504 loan funds (every $100,000 if the 

project involves a small manufacturer). This requirement is a key 

requirement of the 504 loan program that promotes economic 

development within CDCs’ communities. SBA officials we spoke with 

acknowledged that they do not regularly request and examine supporting 

documentation to review the data on jobs supported in CDCs’ annual 

reports. However, SBA officials stated they may request supporting 

documentation if information appears to be unrealistic based on their 

experience. All 10 CDCs we spoke with stated that SBA had not 

requested supporting documentation for the jobs-supported information 

that they reported in their annual reports. As discussed previously, SBA 

also uses CDC-reported jobs data to report on the status of the jobs-

 

45This annual report includes submission of financial statements audited by an 

independent certified public accountant for CDCs with 504 loan portfolio balances of $20 

million or more or, at a minimum, a review by an independent certified public accountant 

or independent accountant in accordance with generally accepted accounting principles 

for CDCs with 504 loan portfolio balances of less than $20 million. 13 C.F.R. § 120.826(c). 
 

Page 26 GAO-14-233 504 Loan Program

supported performance indicator. Federal internal control standards 

emphasize the need for federal agencies to have control activities in 

place to help ensure that program participants report information 

accurately.46 Control activities are the policies, procedures, and methods 

that enforce management directives. In addition, our guidance on data 

reliability recommends tracing a sample of data records to source 

documents to determine whether the data accurately and completely 

reflect the source documents.47 Finally, our guidance on performance 

measurement states that data used to report on performance indicators 

should be sufficiently complete, accurate, and consistent.48 Because SBA 

does not request and review at least some supporting documentation 

during its reviews of CDCs’ annual reports, it lacks assurance that jobs 

data are supported and that CDCs are meeting a key economic 

development goal. It also lacks assurance that data it uses to report on 

the jobs-supported performance indicator are supported.

The annual report review template also does not require an assessment 

of whether CDCs are complying with the retained-earnings requirement, 

which is intended to help ensure that earnings are used to fund additional 

economic development activities. SBA 504 loan program regulations 

require that any funds generated from 504 loan activity remaining after 

payment of staff and overhead expenses be retained by the CDC as a 

reserve for future operations or for investment in other local economic 

development activity.49 SBA officials stated that they review whether 

CDCs are complying with this requirement as part of their review of the 

financial statements in CDCs’ annual reports. However, the annual report 

review template does not list an item requiring an assessment of 

compliance with this requirement. In February 2013, SBA published a 

proposed rule that would require, among other things, a CDC’s Board of 

Directors to approve all investments over $2,500 and the CDC manager 

to approve investments of $2,500 or less to help ensure that the 

investments constitute appropriate economic development activity and do 

 

46GAO/AIMD-00-21.3.1.

47GAO, Assessing the Reliability of Computer-Processed Data, GAO-09-680G

(Washington, D.C.: July 2009).

48GAO/GGD-96-118. 

4913 C.F.R. § 120.825. 
 

Page 27 GAO-14-233 504 Loan Program

not compromise the adequacy of the reserves.50 However, the proposed 

rule does not include a description of plans for SBA’s review of the Board 

of Directors and CDC manager’s approvals of these investments. As of 

December 2013, SBA had drafted a final rule and submitted it to the 

Office of Management and Budget for review. Federal internal control 

standards indicate that federal agencies should have the information 

necessary to determine compliance with laws and regulations.51 Because 

the annual report template does not require a review of compliance with 

the retained-earnings requirement, SBA cannot be assured that district 

office or other staff are consistently reviewing CDCs’ annual reports for 

this requirement or that CDCs are compliant with this requirement.

SBA has an additional eligibility review process for CDCs with ALP 

authority. According to SOP 50 10, these CDCs are accountable for 

thorough credit and eligibility analysis on loan applications and on 

servicing actions. SBA relies on the CDC’s credit analyses in making the 

decision to guarantee the debenture and complete the documentation in a 

reduced time frame. CDCs with the ALP designation have increased 

authority to process and close 504 loans. For example, 504 loan 

applications from CDCs with ALP authority are to be processed within 3 

business days (versus 6 business days for regular loans). To be eligible 

for ALP authority, a CDC must, among other things, (1) have permanent 

CDC status, (2) attain priority status (with a Designated Attorney and 

SBA-required insurance), (3) have at least 20 504 loan applications 

approved by SBA within the most recent 3 years, and (4) have a portfolio 

of at least 30 active 504 loans.52 The CDC also must have a record of 

complying with SBA’s 504 policies and procedures and of satisfactorily 

underwriting, closing, and servicing 504 loans.

A CDC applies for ALP authority first through its SBA district office. As 

part of its application, the CDC must provide, among other things, 

information on the experience and qualifications of its staff, the size and 

 

50504 and 7(a) Loan Programs Updates, 78 Fed. Reg. 12,633 (Feb. 25, 2013).

51GAO/AIMD-00-21.3.1.

52To attain priority status, a CDC must have at least one 504 loan closing Designated 

Attorney, adequate experience and expertise in closing 504 loans, a history of presenting 

complete and accurate closing packages, satisfactory SBA performance, a qualified and 

knowledgeable staff, a satisfactory working relationship with its lead SBA office, and 

directors and officers liability insurance with limits of at least $1 million.
 

Page 28 GAO-14-233 504 Loan Program

performance of its 504 loan portfolio, and compliance with 504 

requirements. The CDC reviews by SBA must be current (within the past 

2 years, if applicable), and the CDC must have received an assessment 

of “Acceptable” or “Acceptable with Corrective Actions Required.”

53 The 

district office reviews the ALP application and forwards its 

recommendation to SBA headquarters staff for their final determination. In 

fiscal year 2013, 83 CDCs had ALP authority. ALP status is generally 

provided to CDCs for a period of 2 years, and according to SBA officials, 

renewals usually occur every 1 to 2 years. Ninety days prior to the end of 

its ALP term, a CDC should apply for renewal of its status and submit 

certain information to SBA.54

As shown in figure 6, SBA performs multiple reviews of 504 loan 

application packages to assess whether loan applications comply with 

program requirements. First, SBA’s Sacramento Loan Processing Center 

(SLPC) reviews all loan application packages to determine whether 

borrowers meet the program’s eligibility and creditworthiness

requirements. Second, it also reviews all application packages to assess 

their completeness. Third, SLPC conducts periodic reviews of loan 

applications submitted under its streamlined processing guidelines—

called the Abridged Submission Method (ASM)—to help ensure that a 

CDC’s abbreviated application submitted to SLPC is consistent with the 

complete loan application maintained by the CDC.

 

53Based on the results of its risk-based reviews, SBA assigns CDCs a rating (e.g., 

“Acceptable,” “Acceptable with Corrective Actions Required,” “Less than Acceptable”). 

These reviews and ratings are discussed in more detail later in this report.

54The information a CDC with ALP authority must submit as part of the renewal process 

includes a summary of the experience of the CDC’s staff, including the Designated 

Attorney. 

SBA Has Multiple 

Processes for Reviewing 

504 Loan Applications
 

Page 29 GAO-14-233 504 Loan Program

Figure 6: 504 Loan Application Reviews

At the time of application, the small business must meet SBA’s eligibility 

requirements and with the exception of size, must continue to meet these 

requirements through the closing and disbursement of the loan. The 

applicant must be an operating business; be organized for profit; be 

located in the United States; be small; and demonstrate a need for the 

desired credit. CDCs must certify that credit is not available elsewhere on 

reasonable terms, and the applicant must show that funds are not 

available from alternative sources, including personal resources of the 

principals.

CDCs must submit all 504 loan application packages to SLPC for 

processing. The loan application covers key 504 requirements, including 

the borrower’s capital injection and economic development goals (jobs-
 

Page 30 GAO-14-233 504 Loan Program

created and public policy goals), as well as financial summary 

information, analysis of debt to net worth ratio, and cash flow information. 

CDCs must submit certain documents with the loan application, including 

eligibility information, a credit memorandum, a personal history statement 

for each officer and director and individuals with 20 percent or more 

ownership of the small business, a personal financial statement that is 

current within 90 days for individuals with 20 percent or more ownership, 

a participating lender commitment letter, a balance sheet and income 

statement, and a cash flow analysis. According to SBA’s guidance, the 

credit memorandum should provide a clear representation of the loan 

proposal and a complete analysis of the business, including an analysis 

of management’s ability and the business’s financial capacity. The 

memorandum should also explain why the transaction completely 

satisfies SBA’s credit standards. This memorandum, along with the other 

documents, demonstrates the CDC’s basis for the applicant’s ability to 

repay the loan. For example, SBA requires that a CDC perform a financial 

analysis of the applicant’s repayment ability based on historical income 

statements, tax returns, and projections. The CDC must also analyze 

cash flow because cash flow of the small business applicant is the 

primary source of repayment, not the liquidation of collateral.

According to SBA officials, two SLPC loan officers review all 504 loan 

application packages to determine whether applicants meet SBA’s 

eligibility and creditworthiness requirements. During these reviews, the 

loan officers analyze financial data to determine if the loan satisfies SBA’s 

credit standards and use a checklist to determine whether the project 

fulfills SBA’s eligibility requirements, such as loan eligibility, jobs created 

and retained, and economic development goals. Upon completion of its 

review, SLPC issues an authorization to the CDC if the applicant meets 

the eligibility requirements and is creditworthy.55 Staff may screen out 

applications if information is missing or they have questions about the 

application.56 In effect, screen outs are similar to declines if the CDC fails 

to respond with additional information to resolve the issue. SBA must 

decline a loan request if, for example, a CDC’s financial analysis 

demonstrates that the small business applicant lacks reasonable 

 

55The authorization is SBA’s written agreement between the agency and the CDC 

providing the terms and conditions under which SBA will guarantee a CDC debenture. 

56Screen outs are exceptions that may require follow up and could later be approved or 

declined.
 

Page 31 GAO-14-233 504 Loan Program

assurance of repayment in a timely manner from the cash flow of the 

business. See table 3 for information on the number of loans SBA 

approved, screened out, and declined in recent years. As the table 

shows, the largest number of loans approved in the past 4 fiscal years 

was in 2012. SBA officials told us that most of the screen outs and 

declines stemmed primarily from failure to meet eligibility standards, poor 

credit quality, or incomplete application packages. The officials also told 

us that the agency experienced an increase in loan applications in fiscal 

year 2012 because of the debt refinancing program authorized by the 

Small Business Jobs Act, which expired in September 2012.

Table 3: Loans Approved, Screened Out, or Declined, Fiscal Years 2010-2013

Source: SBA.

Note: Not all of the loans approved in each fiscal year were disbursed during that year, or at all. Our 

analysis of 504 loan data showed that approximately 72 percent of loans approved during fiscal years 

2003-2013 had been disbursed as of March 2013.

During the processing of each 504 loan application, SLPC staff also 

evaluate the completeness of the package and assign a letter grade to 

each application package. This letter grade is later converted to a 

numeric calculation to derive a CDC’s loan package score based on the 

25 most recent loans submitted to SLPC. According to SBA officials, the 

grading is not an indication of the credit quality of the applicant but is 

simply a measure of how complete the application is.57 The grades range 

from “A” to “E,” with “A” being the highest possible rating. SBA converts 

these grades to numeric scores ranging from “1” to “5,” with “1” 

corresponding to “A,” so that a lower score indicates a better rating. SLPC 

determines the rating by evaluating whether the CDC (1) submitted all 

necessary documents and data, (2) completely and accurately analyzed 

the eligibility of the transactions, and (3) produced a complete and 

thorough credit analysis.

 

57SBA does not track and analyze trends in the application scores because they do not 

pertain to credit quality.

Fiscal year Loans approved Loans screened out Loans declined

2010 7,935 284 102

2011 7,720 152 145

2012 9,405 578 265

2013 7,118 208 245
 

Page 32 GAO-14-233 504 Loan Program

SBA uses the loan package score, among other things, to determine a 

CDC’s eligibility to participate in ASM, a streamlined loan application 

processing procedure. Under this process, eligible CDCs can submit 

fewer documents in order to expedite the application process but must 

collect and maintain all required documentation in their files. According to 

SBA officials, while it generally takes about 6 business days to process 

an application package submitted by a regular CDC, the application 

package processing time for a loan submitted under ASM is about 3 

business days. The ASM process facilitates a faster review of application 

packages because loan officers have fewer documents to review. To 

participate in ASM, CDCs must have ALP or Premier Certified Lender 

Program authority or have submitted 10 complete loan packages during 

the preceding 12 months and earned a numeric equivalent average loan 

package score of no more than “2.0” among the 25 most recent loan 

applications submitted to SLPC. While SBA officials told us that they do 

not keep historical records of CDCs that have ASM status, they said 128 

CDCs had this status as of September 2013.

In addition to evaluating all application packages, SBA’s policy requires 

that SLPC conduct periodic reviews of loan applications submitted under 

the ASM processing guidelines. According to SOP 50 10, SBA is to 

review 1 out of every 10 loan applications annually for each CDC. Each 

CDC will have at least 1 but no more than 12 loans reviewed during a 12-

month period. To accomplish this, SLPC randomly selects ASM files to 

review. The primary purpose of these ASM audits is to help ensure that 

the abridged application is consistent with the complete loan application 

file that is maintained by the CDCs and to monitor CDCs’ continued 

eligibility to use ASM. Using a checklist, SLPC staff review the files

selected for the audit to determine, among other things, whether all 

documents that the CDC collected were appropriately signed and dated, 

the project costs were consistent with the cost stated on the abbreviated 

application, financial analysis such as cash flow was correctly 

determined, and the size analysis was correct.

We reviewed the results of five ASM audits conducted between January 

2011 and August 2013 (1,047 files were reviewed) to determine whether 

SLPC was performing these audits as required and what the results 

showed. We found that SBA graded the 1,047 files and reported that the 

one major exception of concern identified during the first four audits was 
 

Page 33 GAO-14-233 504 Loan Program

resolved satisfactorily.58 SBA reported that the fiscal year 2013 audit 

identified some exceptions, which resulted in a 1-year suspension of two 

CDCs’ ASM status. According to SBA officials, when CDCs lose their 

ASM status, they generally do so because they cannot provide all loan 

application documentation they should retain in their files, or the

documentation they submitted to SBA is not properly signed. According to 

SBA’s policy, a CDC will also lose its ASM status if its average loan 

package score for the most recent 25 applications submitted to SLPC 

exceeds 2.0. In addition, the SLPC center director or a designee may 

approve or remove ASM status at any time for good cause including, but 

not limited to, misrepresentation, quality of post approval actions, and 

findings of internal or external audits of the CDC.

As noted previously, significant time (as much as 4 years) can pass 

between approval of the initial 504 loan application and loan closing. 

Therefore, CDCs must issue an opinion, prior to closing, that there has 

been no adverse change in the borrower’s ability to repay the loan prior to 

closing. Prior to closing, a CDC must issue a certification that to the best 

of its knowledge there has been no unremedied substantial adverse 

change in the borrower’s ability to repay the 504 loan since its submission 

of the loan application to SBA. Regular CDCs must provide their finding to 

SLPC along with copies of financial statements that are current within 120 

days supporting the finding of no adverse change.59 If SBA disagrees with 

a CDC’s determination of no adverse change, the debenture will not close 

until SBA has been satisfied that any adverse change has been 

remedied. CDCs with ALP authority are required to conduct a review to 

determine no adverse change but are not required to submit the results of 

this review to SBA. Instead, CDCs with ALP authority retain in their files 

the finding and copies of the financial statements on which they relied. 

According to SBA officials, if a CDC with ALP authority is in good 

standing, SLPC accepts certification that there has been no adverse 

change and does not perform an additional check. If a CDC with ALP 

 

58Loans reviewed during ASM audits are graded using the following four categories: 

acceptable, minor exceptions, major exceptions, and unacceptable. 

59Unlike the requirement that financial statements submitted with the initial application 

must be current within 90 days, financial statements provided to support no adverse 

change must be current within 120 days.

SBA Does Not Verify 

Certifications Made by 

Certain CDCs Prior to 

Closing but Does Conduct 

Some Other Reviews
 

Page 34 GAO-14-233 504 Loan Program

authority is not in good standing, SBA officials stated that the loan file 

would not be approved.

According to SBA officials, SBA reviews CDCs’ ALP authority for renewal 

every 1 to 2 years. We found that the assessment form SBA uses when 

determining whether to renew ALP authority does not include a step 

verifying that CDCs with ALP authority can support their certification that 

there was no adverse change in a borrower’s ability to repay the loan 

after initial submission of the loan application. SBA officials confirmed that 

they have not reviewed CDCs with ALP authority for compliance with this

requirement. They stated that CDCs were closely scrutinized before SBA 

granted them ALP authority and that any problems with certifying that 

there were no adverse changes would show up in loan performance data 

or in OCRM reviews of the CDC. However, federal internal control 

standards require that federal agencies have control activities in place, 

such as verification, to ensure compliance with key program 

requirements.60 Furthermore, annually since 2005, more 504 funds have 

been loaned using ALP authority than regular authority. In fiscal years 

2010 through 2012, the dollar amount of 504 loans made with ALP 

authority was about twice the dollar amount of regular 504 loans.61

Without incorporating a step in its renewal process to assess compliance 

with this requirement, SBA cannot be assured that CDCs with ALP 

authority are meeting the requirement.

SBA district office counsel conduct other reviews in conjunction with loan 

closing. CDCs and their attorneys are responsible for the 504 loan 

closing, including compliance with all SBA loan program requirements. 

The SBA district office counsel reviews the closing documents submitted 

by the CDC for legal sufficiency and issues a legal opinion on whether 

SBA may guarantee the debenture. The SBA officials we spoke with told 

us that the counsel also reviews SBA’s authorization and all modifications 

transmitted by SLPC. If the counsel determines that a loan was not 

closed properly, he or she notifies the CDC of the deficiencies in the 

package as well as changes needed to address the concern. If the CDC 

 

60GAO/AIMD-00-21.3.1.

61In fiscal years 2010 and 2011, loans made with ALP authority totaled $3.05 billion and 

$3.07 billion, respectively, and $1.36 billion and $1.56 billion for regular loans, 

respectively. In fiscal year 2012, loans made with ALP authority totaled $3.03 billion 

versus $1.47 billion for regular loans. 
 

Page 35 GAO-14-233 504 Loan Program

is unable to provide the information or otherwise alleviate the concern, the 

counsel will not submit the debenture for sale. According to SBA officials, 

SBA rarely declines to close a debenture. Usually, declines occur early in

the loan approval process.

SBA has made several changes to its processes used to monitor CDC 

compliance with 504 program requirements, including revising the areas 

to be reviewed and the types of reviews to be conducted. However, the 

processes have not been finalized, and review of certain key 

requirements is not yet documented. Further, SBA is updating its 

corrective action process to improve review of actions taken.

According to the OCRM Director, SBA is finalizing a new process for 

monitoring CDCs and developing its first risk plan for 2014. According to 

SBA officials, the plan will be used to monitor CDC performance and 

enforce 504 program requirements. They noted that it will include the 

OCRM Director’s objectives for the year ahead; lender and loan portfolio 

stratifications; a description of the types of lender reviews OCRM will be 

undertaking; a proposed list of planned reviews; proposed supervisory 

and enforcement actions; and a section on matters internal to OCRM 

(e.g., policy updates, training, and staffing). OCRM expects to finalize this 

plan by March 31, 2014.

As a part of its new process, OCRM is incorporating risk as a criterion for 

selecting CDCs for review. Based on data in its Loan and Lender 

Monitoring System, SBA assigns all CDCs a quarterly risk rating of 1 to 

5.62 A rating of “1” reflects lower risk to SBA, and “5” reflects greater 

risk.63 In a November 2009 report, we recommended that SBA use its risk 

ratings to select CDCs for review.64 At that time, the agency targeted 

 

62The Loan and Lender Monitoring System is the system SBA uses to monitor the 

individual risk that each loan poses to the agency in order to identify lenders whose SBA 

loan operations and portfolios may require additional monitoring or other actions.

63Of the 267 active CDCs as of September 30, 2013, 66 were rated “1”; 126 were rated 

“2”; 58 were rated “3”; 13 were rated “4”; and 4 were rated “5.” 

64GAO-10-53. 

SBA Is Implementing 

a New Approach to 

Monitoring CDC 

Compliance but Has 

Not Yet Documented 

Key Processes

SBA’s New Review 

Process Covers Five 

Areas of CDC Operations 

and Tailors the Level of 

Review Based on Risk
 

Page 36 GAO-14-233 504 Loan Program

CDCs for review based on the size of their portfolios, focusing on CDCs 

with balances of at least $30 million. In fiscal year 2012, OCRM began 

incorporating risk ratings into its CDC selection criteria. OCRM placed 

emphasis on CDCs that were rated “4” or “5” (higher risk). In fiscal year 

2013, SBA selected a number of CDCs for review and prioritized them 

based on risk ratings and other factors, such as portfolio size, time 

elapsed since last review, and last review assessment.

The OCRM Director also told us that the agency is developing a new 

process for assessing CDCs that have been selected for review, but this 

process is not yet finalized. Draft guidance on this new process, known as 

SMART, shows that SBA has developed preliminary benchmarks to 

assess each CDC’s performance and compliance under five areas: 

Solvency and financial condition, Management and board governance, 

Asset quality and servicing, Regulatory compliance, and Technical issues 

and mission. Figure 7 illustrates the SMART components and examples 

of preliminary benchmarks that are to be used to assess CDCs’ activities. 

In February 2014, the OCRM Director told us that the agency expects to 

finalize these benchmarks by March 31, 2014.
 

Page 37 GAO-14-233 504 Loan Program

Figure 7: Description of the Proposed SMART Process, as of January 2014

In general, once CDCs have been selected for review, the benchmarks 

and CDC risk ratings are to be used to determine the level of review. 

Under the new review process, SBA plans to conduct three types of riskbased reviews—select analytical reviews, targeted reviews, and full 

reviews (see fig. 8). A select analytical review will be OCRM’s initial 

review of a CDC’s operations and performance. A targeted review will 

examine specific components of SMART in more detail, and a full review 

will examine all components of SMART in more detail. Targeted and full 

reviews are only to be performed if the select analytical review indicates 

that they are warranted.65 For each CDC selected, OCRM plans to notify 

the CDC of the planned select analytical review and request documents 

such as a current organizational chart, interim financial statements, and 

 

65SBA officials stated that OCRM may, from time to time, select lenders for full on-site 

reviews even if their ratings or benchmarks are “good.” For example, SBA officials stated 

that they may occasionally review lenders with very large portfolios on-site. 
 

Page 38 GAO-14-233 504 Loan Program

credit policy manual. In addition, based on its draft guidance, OCRM 

plans to use a questionnaire to inquire about, among other things, any 

significant changes regarding delegations, responsibilities, and structure 

since the CDC’s last risk-based review or submission of its last annual 

report. The OCRM Director said OCRM also intends to solicit information 

about the CDC from SLPC, the commercial loan servicing center that 

works with the CDC, and SBA’s district office counsel. According to SBA 

officials, OCRM does not initially plan to request loan files in connection 

with select analytical reviews. However, they stated that OCRM could 

decide to review loan files in the future. To perform a select analytical 

review, OCRM plans to use a CDC profile assessment template to 

analyze and document review of a CDC’s activities aligned with each of 

the SMART components. Further, OCRM intends to summarize the 

findings of the review as well as the review assessment on a report 

summary template.

Figure 8: Proposed Risk-Based Review Process

Based on our review of draft guidance, each component of SMART is to 

receive one of three assessment scores—Preferred, Acceptable, or Less 

than Acceptable with Corrective Actions. In addition, CDCs are to receive 

one of four overall review assessments after their review is completed—

Acceptable, Acceptable with Corrective Actions Required, Marginally 
 

Page 39 GAO-14-233 504 Loan Program

Acceptable with Corrective Actions Required, or Less than Acceptable 

with Corrective Actions Required. Select analytical reviews are to be 

conducted remotely, and the results will determine whether a targeted or 

full review is necessary. They also are to be used to assess CDCs for 

renewal of their ALP authority. OCRM plans to align risk-based reviews 

with ALP renewals because during its risk-based reviews OCRM 

analyzes information similar to that reviewed during ALP renewals. In 

addition, OCRM has expanded the scope of the ALP renewal analysis to 

include a review of issues such as the structure of the organization, 

board-approved internal control policy, and industry concentrations. In 

fiscal year 2013, 83 CDCs had ALP authority. Of those CDCs with ALP 

authority, 65 were due for renewal in fiscal year 2013. SBA reported that 

they completed 15 of those renewals in fiscal year 2013. SBA officials 

commented that they are addressing the backlog by dividing the process 

by risk rating. They explained that most of the CDCs with a 4 or 5 risk 

rating are undergoing a SMART select analytical review before a longerterm ALP renewal is considered. OCRM provided lenders with risk ratings 

of 1, 2, and 3 with temporary extensions of their ALP status. SBA officials 

also noted that OCRM has devoted additional staff to reviewing and 

processing ALP renewals beginning in calendar year 2014.

According to SBA’s draft guidance, if a select analytical review identifies 

risks, OCRM is to perform a targeted or full review. In a targeted review, 

OCRM would focus on the aspects of the CDC and its operations that 

warrant further attention, based on the SMART components. For 

example, the OCRM Director told us that OCRM may target areas such 

as loan originations, loan authorizations that may not have been funded, 

or financial statement matters. SBA officials told us that in deciding to 

conduct a targeted review, OCRM plans to consider a CDC’s risk rating 

and loan purchases and apply some judgment in addition to the results of 

the select analytical review. OCRM plans to conduct a full review when 

the select analytical review identifies issues that are critical or crucial in 

nature. A full review would involve examining all components of SMART. 

A targeted or full review may be conducted remotely or on-site. An on-site 

review is to be used if CDCs do not have technological capabilities for 

remote reviews or if OCRM needs to observe an activity as it is being 

performed.

In 2013, OCRM initiated 20 select analytical reviews and 5 on-site 

reviews using the SMART protocol. According to the OCRM Director, the 

purpose of these reviews was to continue developing the new compliance 

processes, as well as providing oversight of CDCs. There were more total 

reviews in fiscal year 2013 than in previous years but fewer on-site 
 

Page 40 GAO-14-233 504 Loan Program

reviews. In fiscal year 2011 and fiscal year 2012, SBA conducted 21 and 

19 on-site risk-based reviews, respectively. Staff from various SBA offices 

and contractor staff hired to conduct risk-based reviews participated in the 

fiscal year 2013 reviews and will continue to do so. Previously, only 

contractors, not SBA staff, conducted on-site reviews.

SBA officials told us that as part of SBA’s targeted and full risk-based 

reviews, OCRM has begun to request two samples of loan files—

origination loan files and servicing loan files.66 OCRM currently uses two 

checklists to review individual loan files. One checklist primarily includes 

questions about loan origination and routine servicing such as whether 

the business was organized for profit, whether there was written evidence 

documenting that credit was not available elsewhere without the 

guarantee provided by SBA, and whether monitoring of continued 

creditworthiness is considered sufficient and describes the evidence in 

the file. The other checklist includes questions for defaulted loans in 

liquidation status on loan closing and servicing, such as whether evidence 

shows that all closing documents were legally sufficient and that the CDC 

engaged in intensive servicing activities when a loan became 60 days 

past due. OCRM plans to eventually merge the checklists as it refines the 

new process. According to SBA officials, prior to 2012 OCRM did not 

routinely examine a sample of servicing files. Instead, it performed 

reviews of CDCs’ servicing files on an ad hoc basis. SBA officials told us 

that servicing issues emerged in 2012 because there was a lag effect for 

real estate loans after the economic downturn.

Many aspects of the new SMART process have not been finalized. For 

instance, the OCRM Director told us that the agency is assessing the 

results of a benchmark study, which will be used to finalize the 

benchmarks used to rate CDCs on the various SMART components. 

Also, OCRM has not yet finalized the assessment templates used for 

select analytical reviews or the checklist used for targeted and full 

reviews. According to the OCRM Director, these forms are evolving with 

OCRM’s review processes. In addition, OCRM is considering creating a 

composite CDC risk grade, similar to a bank’s CAMELS rating, to assess 

 

66OCRM intends to request samples of loan files on targeted reviews when the scope of 

the review includes matters that can only be assessed through the review of loan files.
 

Page 41 GAO-14-233 504 Loan Program

the overall condition of a CDC.67 These grades would help communicate 

to CDCs how they are doing with respect to the overall quality of their 

operations, compliance, and portfolio risks. According to the OCRM 

Director, SBA expects to fully implement SMART by June 1, 2014.

As noted previously, OCRM currently uses two checklists to review loan 

files as a part of its risk-based reviews. One checklist primarily focuses on 

origination and routine servicing, while the other focuses on loan closing 

and servicing of problem loans. However, OCRM’s current compliance file 

review checklists do not require a review of documentation supporting the 

numbers reported by CDCs for jobs created or supported. SBA officials 

told us that in the past OCRM did not examine documentation supporting 

jobs data, but that such a review would be included under the SMART 

process. Based on our review of SBA’s draft SMART protocols, under the 

Asset quality and servicing component OCRM staff are expected to 

determine whether 504 projects meet specified economic development 

goals and job opportunity criteria. Furthermore, under the Technical 

issues and mission component, staff are expected to determine whether a 

CDC’s loan portfolio meets the required minimum job opportunity 

average. While some oversight has been built into the SMART guidance, 

the guidance does not call for a review of documentation supporting the 

jobs numbers.

OCRM’s current compliance file review checklists also do not require the 

review of whether retained earnings were used in compliance with CDC 

eligibility requirements. SBA staff told us that in the past OCRM did not 

examine CDCs’ compliance with the requirement that CDCs retain excess 

funds generated from the 504 loan program as a reserve for future 

operations or for investment in other local economic development activity, 

but that assessing compliance with this requirement would be included 

under SMART. Based on our review of SBA’s draft SMART protocol, 

under the Solvency and financial condition component OCRM is expected 

to analyze whether the CDC has sufficient cash flow to support ongoing 

operations and the reserve requirement. However, there is no specific 

 

67CAMELS is a supervisory rating system used to classify a bank’s overall condition. 

Institutions are judged on six different components under the acronym C-A-M-E-L-S: 

capital adequacy, asset quality, management, earnings, liquidity, and sensitivity to market 

risks. Banks receive a score of 1 to 5 for each component, and a final CAMELS score in 

that same range represents the composite total of the components.

SBA’s Review of Key 

Requirements Is Not Yet 

Documented
 

Page 42 GAO-14-233 504 Loan Program

mention of verifying compliance with the retained-earnings requirement 

concerning how the reserves can be used. According to federal internal 

control standards, federal agencies should have control activities in place 

to help ensure compliance with key requirements.68 Without documenting 

in its examiner checklists or guidance that key requirements—such as the 

jobs-supported and retained-earnings requirements—should be reviewed, 

SBA cannot be assured that SBA and contractor staff are reviewing 

compliance.

SBA is revising its corrective action process. According to the OCRM 

Director, if SBA identifies weaknesses in a CDC’s operations during its 

reviews, it may request that the CDC take corrective actions to address 

the deficiencies. For instance, if SBA determines that a CDC’s credit 

analysis is deficient, the CDC may be required to modify its process for 

performing credit analyses. OCRM documents its review findings in a 

report and notifies the CDC in writing if there is a need for corrective 

actions. In its September 2012 report, SBA’s Inspector General reported 

that SBA had closed out corrective actions related to the 7(a) program 

without verifying their implementation and effectiveness.69 The Inspector 

General recommended that SBA develop and implement a corrective 

action follow-up process to require analysts to monitor lender progress in 

implementing corrective actions and obtain and verify evidence from 

lenders to ensure corrective actions have been effectively implemented 

prior to close-out. While the Inspector General’s review pertained to the 

7(a) loan program, the process in use at the time also was used for the 

504 loan program. SBA officials told us they are in the process of 

developing a new corrective action process to capture more specific 

findings from reviews and to determine whether testing of a CDC’s 

corrective responses is needed prior to the CDC’s next review. See table 

4 for information on the number of reviews that required corrective actions 

in recent years.

 

68GAO/AIMD-00-21.3.1. 

69SBA, Office of Inspector General, Addressing Performance Problems of High-Risk 

Lenders Remains a Challenge for the Small Business Administration, Report no. 12-20R 

(Washington, D.C.: Sept. 28, 2012).

SBA Is Revising Its 

Corrective Action Process 

to Improve Review of 

Actions Taken
 

Page 43 GAO-14-233 504 Loan Program

Table 4: Number and Results of Risk-Based Reviews, Fiscal Years 2007-2012 

 Acceptable

Acceptable with 

corrective actions 

Marginally

acceptable with

corrective actions

Less than

acceptable with

corrective actions

Total number

of reviews

2007 1 43 0 1 45

2008 6 56 1 0 63

2009 11 42 0 4 57

2010 0 21 0 2 23

2011 2 10 0 9 21

2012 1 6 2 10 19

Total 21 178 3 26 228

Source: SBA.

From October 1, 2010, through March 31, 2012, SBA identified some 

frequently occurring findings, including inadequate verification of the 

borrower’s contribution prior to closing, failure to meet Internal Revenue 

Service tax transcript requirements prior to closing, and failure to assess 

creditworthiness periodically. According to the OCRM Director, SBA 

expects to complete the new processes for resolving corrective actions by 

March 31, 2014.

SBA is developing new processes for monitoring 504 loan performance 

and CDCs’ compliance with 504 requirements. However, SBA’s current 

processes and planned improvements do not sufficiently address all 

program requirements. Creating and retaining jobs is a key economic 

development goal of the 504 program. While SBA has provided general 

guidance to CDCs and its staff on compliance with this requirement, it has 

not provided CDCs with specific guidance needed to consistently and 

accurately compile and support jobs information. Further, SBA’s current 

annual report review and risk-based review guidance do not require SBA 

staff to request and review supporting documentation for CDC-reported 

data on jobs supported or assess compliance with the requirement that 

CDCs invest retained earnings in local economic development. Federal 

internal control standards require agencies to establish control activities 

to ensure that program participants report information accurately and 

comply with requirements.70 Without developing guidance for CDCs and 

 

70GAO/AIMD-00-21.3.1.

Conclusions
 

Page 44 GAO-14-233 504 Loan Program

reviewing at least some documentation on jobs data and compliance with 

the retained-earnings requirement, SBA cannot be assured that selfreported information on jobs supported is consistent and accurate and 

that CDCs are following program requirements.

In addition, while SBA has established multiple reviews for 504 loan 

applications, the agency does not verify certifications made by CDCs with 

ALP authority that borrowers are still able to repay a 504 loan at loan 

closing, which can take place years after the loan was initially approved. 

Again, federal internal control standards require agencies to have control 

activities in place, such as verifying compliance with key requirements.71

Annually since 2005, more 504 loans have been made using ALP 

authority than regular authority, making the need for some review of these 

certifications all the more important. Without verifying self-certifications 

made prior to loan closings, SBA lacks assurance these CDCs are in 

compliance with SBA credit analysis requirements established to help 

protect against default risk.

To help ensure that CDCs are meeting the 504 loan program’s jobssupported requirement, we recommend that the SBA Administrator take 

the following actions:

• Develop specific guidance on how CDCs should compile information 

on jobs created or retained and on the documentation CDCs should 

maintain to support these data.

• When reviewing CDCs’ annual reports, implement a process to 

assess the supporting documentation for a sample of the jobs data 

that CDCs report.

• When finalizing the agency’s risk-based review procedures, include in 

the checklists or guidance for examiners a requirement to review 

supporting documentation on the number of jobs created or retained 

by 504 loan projects.

 

71GAO/AIMD-00-21.3.1. 

Recommendations for 

Executive Action
 

Page 45 GAO-14-233 504 Loan Program

To help ensure that CDCs are meeting the 504 loan program’s 

requirement that CDCs invest retained earnings in local economic 

development, we recommend that the SBA Administrator take the 

following actions:

• When reviewing CDCs’ annual reports, add an item to its annual 

report review template requiring SBA staff to assess compliance with 

this requirement.

• When finalizing the agency’s risk-based review procedures, include in 

the checklists or guidance for examiners a requirement to review 

compliance with the retained-earnings requirement.

To help ensure that CDCs with ALP authority are taking the necessary 

steps to determine whether there has been no adverse change to 

borrowers’ financial condition prior to loan closing, we recommend that 

the SBA Administrator include oversight of CDCs’ compliance with this 

requirement in the agency’s process for renewing ALP authority.

We requested comments from SBA on a draft of this report, and the 

agency provided written comments that are presented in appendix II. SBA 

generally agreed with our recommendations and outlined steps it plans to 

take to address them. In response to our recommendations regarding the 

504 loan program’s jobs-supported requirement, SBA stated that it will (1) 

work to provide guidance on the compilation of job creation and retention 

information and document maintenance requirements and (2) consider 

ways to phase in the implementation of jobs data sampling and review of 

supporting documentation in its annual report and risk-based reviews. In 

regard to our recommendations concerning the 504 loan program’s 

retained-earnings requirement, SBA stated that a final rule discussing 504 

loan program updates (not yet finalized at the time of SBA’s comment 

letter) will require that a CDC’s annual report include a written report on 

the CDC’s investments in local economic development. SBA stated that 

after publication of the final rule, it plans to work to provide additional 

guidance on the retained-earnings requirement and consider ways to 

review compliance with this requirement in its annual report and riskbased reviews. In response to our recommendation regarding CDCs with 

ALP authority, SBA stated that it will consider ways to review compliance 

with the requirement to determine whether there has been an adverse 

change to borrowers’ financial condition prior to loan closing during SBA’s 

ALP renewal processes and risk-based reviews. As noted in the report, a 

504 loan is not closed until after project-related construction is complete, 

Agency Comments

and Our Evaluation
 

Page 46 GAO-14-233 504 Loan Program

which can be up to 4 years after initial approval. Given that a borrower’s 

financial condition can change over time, we reiterate the importance of 

assessing CDCs’ compliance with this requirement.

SBA also provided several technical comments, which we incorporated as 

appropriate. In one technical comment regarding our discussion of the 

need for SBA to review some supporting documentation for jobs data 

during its review of CDCs’ annual reports, SBA’s Associate Administrator 

of the Office of Capital Access stated that validating job creation and 

retention data can only occur following loan disbursement and is a 

separate issue from the indicator on jobs supported that SBA includes in 

its performance report. As we discuss in the report, SBA uses the data 

captured in SBA’s loan application system at the time of loan approval 

(which are estimates) when compiling the jobs supported indicator. CDCs’ 

annual reports contain both estimated and actual jobs data for 504 loan 

projects. Therefore, adding reviews of supporting documentation for a 

sample of jobs data—both actual and estimated—during the annual 

report review process could also inform CDCs’ processes for compiling 

estimates for jobs created or retained in their loan applications, and 

provide better assurance that the data used for the jobs supported 

indicator are supported.

As agreed with your offices, unless you publicly announce the contents of 

this report earlier, we plan no further distribution until 30 days from the 

report date. At that time, we will send copies of this report to SBA and 

interested congressional committees. The report also will be available at 

no charge on the GAO website at http://www.gao.gov.

If you or your staff have any questions about this report, please contact 

William B. Shear at (202) 512-8678 or shearw@gao.gov. Contact points 

for our Offices of Congressional Relations and Public Affairs may be 

found on the last page of this report. GAO staff who made major 

contributions to this report are listed in appendix III.

William B. Shear

Director, Financial Markets and

 Community Investment
Appendix I: Objectives, Scope, and 

Methodology

Page 47 GAO-14-233 504 Loan Program

Our objectives were to examine (1) the lending standards and 

performance indicators that the Small Business Administration (SBA) has 

established to help ensure that loans meet key requirements, as well as 

504 loan program performance, (2) the extent to which SBA has 

implemented procedures to help ensure that certified development 

companies (CDC) are eligible to participate in the program and that loan 

applications comply with program requirements, and (3) the extent to 

which SBA has implemented procedures to monitor CDC compliance with 

program requirements.

To address these objectives, we reviewed relevant laws and regulations; 

GAO and SBA Inspector General reports; SBA guidance for the 504 loan 

program, including Standard Operating Procedures (SOP), the form used 

to apply for 504 loans, and checklists for different SBA processes; and 

internal SBA guidance for its staff and examiners. We interviewed 

relevant staff at SBA, the National Association of Development 

Companies (the trade association for the 504 loan program), and staff 

from 10 CDCs. We selected these CDCs to ensure a range of CDCs 

based on factors such as size and geographic location. Specifically, we 

selected one CDC from each of SBA’s 10 regions based on loan portfolio 

size. We used the five peer groups that SBA uses for monitoring 

purposes to establish which CDCs were large versus small.1 To ensure a 

mix of large and small CDCs and geographic locations, we selected 7 

large CDCs from the regions with the largest 504 loan portfolios and 3 

small CDCs from the regions with the smallest 504 loan portfolios. As a 

secondary measure, we considered the default rates, as calculated by 

GAO, of the selected CDCs to ensure that we selected CDCs that had a 

mix of default rates.2 Five of the 10 CDCs had default rates below 10 

percent, and 5 had default rates of 12 percent or higher. Due to ongoing 

litigation related to a subset of CDCs known as Premier Certified Lenders, 

 

1

The peer groups, as defined by outstanding dollars of SBA debentures, are CDCs with 

(1) $100 million or more; (2) $30 million to $99,999,999; (3) $10 million to $29,999,999; (4) 

$5 million to $9,999,999; and (5) $0 to $4,999,999. 

2

In our analysis, we determined that a 504 loan had defaulted if SBA had purchased the 

loan’s associated debenture. SBA guidance states that a good faith effort should be made 

to help delinquent borrowers bring their loans current. But, when a payment default cannot 

be cured, the loan should be classified as in liquidation and the CDC should immediately 

request that SBA purchase the loan’s associated debenture. The default rate is the total 

number of loans that had defaulted divided by the total number of loans approved in a 

given fiscal year.

Appendix I: Objectives, Scope, and 

Methodology
Appendix I: Objectives, Scope, and 

Methodology

Page 48 GAO-14-233 504 Loan Program

we did not assess loans made using the specific additional authority that 

SBA may provide to these lenders.3

To respond to our first objective, we reviewed relevant laws, regulations, 

and SOPs to identify SBA’s lending standards and servicing policies. We 

then compared SBA’s guidance on compiling data on jobs created and 

retained with 504 loan funds to federal internal control standards.4 We 

also reviewed SBA’s annual performance reports for fiscal years 2010 

through 2012 to identify SBA’s performance measures for the 504 loan 

program and assessed whether they addressed the program’s economic 

development goals and were consistent with GAO standards for 

performance measurement.5 In addition, we reviewed documentation on 

SBA’s processes for reviewing and validating its performance indicators.

We also analyzed 504 loan data for fiscal years 2003 through 2013 (as of 

Mar. 31, 2013) to determine the composition and performance of the 

current 504 loan portfolio.6 For example, we analyzed default rates (the 

number of 504 loans whose debentures were purchased divided by the 

total loans approved in that fiscal year) and 18-month default rates for 

loans approved in fiscal years 2003 through 2012.7 We only analyzed 

 

3

See United States ex rel. U.S. Small Bus. Admin. v. EDF Res. Capital, Inc., No. 2:13-cv01158 (E.D. Cal.). The litigation is an enforcement action by SBA against EDF for, among 

other things, EDF’s alleged failure to pay amounts owed as a Premier Certified Lender to 

SBA. Under GAO’s policy to avoid addressing disputed factual or legal matters pending in 

litigation, we did not evaluate these matters, including the liquidation of defaulted loans, 

enforcement actions, or any loans made using Premier Certified Lender legal authority. 

4

GAO, Standards for Internal Control in the Federal Government, GAO/AIMD-00-21.3.1

(Washington, D.C.: November 1999). 

5

GAO, Executive Guide: Effectively Implementing the Government Performance and 

Results Act, GAO/GGD-96-118 (Washington, D.C.: June 1996).

6

Data as of March 2013 were the most recent available data at the time of our request. 

The 504 data set analyzed does not include any data on loans issued by CDCs using 

Premier Certified Lender Program authority or any non-Premier Certified Lender Program 

loans issued by the CDC with Premier Certified Lender Program authority that is involved 

in the pending litigation. The amount excluded totaled 9,233 loans and approximately $5.9 

billion. The data set provided by SBA included 80,080 loans totaling approximately $47 

billion. However, based on conversations with SBA, we limited the analysis to loans that 

had been disbursed—61,171 loans totaling about $34 billion. 

7

The 18-month default rate is the number of loans that defaulted within 18 months of 

disbursal divided by the total number of loans approved in a given fiscal year.
Appendix I: Objectives, Scope, and 

Methodology

Page 49 GAO-14-233 504 Loan Program

loans that were approved as of March 2013 and had been disbursed.8

According to SBA, the 18-month default rate is an indicator of default 

primarily due to poor underwriting. We also calculated default rates 

weighted by the approved values of loans and found the rates 

comparable to the rates discussed above.

For context, we reviewed Moody’s/REAL Commercial Property Price 

Index data for 2002 through 2010 on commercial real estate values. We 

also compared 504 loan data to Federal Deposit Insurance Corporation 

quarterly analysis of Federal Financial Institutions Examination Council 

call report data on nonaccrual rates for commercial loans, specifically 

construction and development loans and real estate loans.9 We 

calculated the nonaccrual rate for commercial loans as the percentage of 

loan dollars in nonaccrual status. Loans in nonaccrual status are 

generally loans that are maintained on a cash basis because of the 

deterioration in the financial condition of the borrower and for which 

principal or interest has been in default for at least 90 days (unless the 

loan is in “the process of collection” and “well secured”) or payment in full 

is not expected. We divided the dollar value of loans in nonaccrual status 

by the total amount of outstanding loan dollars for the quarter of that 

calendar year. We used nonaccrual status as a trend comparison 

because it was the weakest category of loans and most similar to 

purchases made by SBA. In order to compare 504 loan data with this 

rate, we calculated the percentage of defaulted 504 loans that were 

disbursed within the past 2 years for each quarter of the calendar year. 

However, while trends may be compared, levels of nonaccrual rates and 

SBA default rates may not be compared as SBA data represent early 

defaults only and the call report data represent nonaccruals for total 

outstanding loans. We also compared 504 loan default rates and 18-

month default rates by geographic location by analyzing these rates for 

loans based on the location of CDCs making the loans.10 This analysis 

 

8

As discussed previously in this report, the disbursement of 504 loans does not occur at 

the time of approval, but can occur, at a maximum, up to 4 years later. About 28 percent 

of the loans in the data set SBA provided had not been disbursed as of March 2013.

9

A “call report” is a report that must be filed by all insured depository institutions in the 

United States on a quarterly basis and contains financial information about the institutions. 

The report is officially known as the Report of Condition and Income. 

10The majority of CDCs serve the state in which they are headquartered, which is their 

“area of operations.” A few CDCs have received permission to serve contiguous 

communities located across multiple states. 
Appendix I: Objectives, Scope, and 

Methodology

Page 50 GAO-14-233 504 Loan Program

covers all states with CDCs, the District of Columbia, and Puerto Rico. 

(There is no CDC located in Alaska.) To assess the reliability of the SBA 

loan-level data, we interviewed SBA representatives from the Office of 

Performance and Systems Management about how they collected the 

data and helped ensure data integrity. We also reviewed documentation 

about the sources of the data and performed electronic testing to detect 

errors in completeness and reasonableness. We determined that the data 

were sufficiently reliable for the purpose of reporting on portfolio 

composition and performance. To assess the reliability of the 

Moody’s/REAL Commercial Property Price Index and Federal Deposit 

Insurance Corporation quarterly analysis of call report data we used, we 

reviewed prior GAO assessments of the reliability of this data. We 

determined the data were sufficiently reliable for the purpose of 

comparing trends in related private sector loan program performance and 

SBA 504 loan program performance.

To respond to our second objective, we identified SBA’s compliance 

processes for overseeing CDC eligibility and loan approval. To determine 

whether SBA had implemented compliance procedures to help ensure 

that CDCs are eligible and that loan applications comply with program 

requirements, we reviewed (1) checklists SBA uses to review CDCs’ 

eligibility and renew CDCs’ Accredited Lenders Program (ALP) authority, 

(2) the template used to review CDCs’ annual reports, (3) checklists used 

to review applicant eligibility and creditworthiness, and (4) checklists used 

to conduct Abridged Submission Method (ASM) audits. We also reviewed 

the data on these processes, including the results of SBA’s loan 

application review processes for fiscal years 2010 through 2013 and 

results of ASM audits performed between January 2011 and August 2013 

to determine whether SBA was performing these audits as required and 

review their results. We assessed the reliability of the data on these 

processes by interviewing officials knowledgeable about the data and 

determined that they were sufficiently reliable for the purpose of 

discussing the results of SBA’s compliance processes. We also reviewed 

504 loan data on the amounts of loans made with ALP authority versus 

regular authority from fiscal years 2003 through 2012. These data came 

from the same SBA data system as the set of 504 loan data discussed 

previously, which we found reliable for the purposes of this report. Finally, 
Appendix I: Objectives, Scope, and 

Methodology

Page 51 GAO-14-233 504 Loan Program

we assessed whether the above processes were consistent with federal 

internal control standards.11

To respond to our third objective, we assessed SBA’s monitoring of 

CDCs’ compliance with program requirements. To determine whether 

SBA implemented compliance procedures to monitor CDC compliance, 

we reviewed documentation on SBA’s (1) CDC risk-rating processes; (2) 

previous compliance processes as represented in relevant SOPs and 

other guidance; and (3) new preliminary “SMART” approach to monitoring 

CDCs, including risk-based review checklists, draft protocols, preliminary 

benchmarks, and CDC profile assessment templates. We also reviewed 

the data on these processes, including data on lender risk ratings as of 

September 2013 and the results of SBA’s risk-based reviews from fiscal 

years 2007 through 2012, to assess the extent to which SBA was 

implementing its compliance processes. We assessed the reliability of 

these data by interviewing officials knowledgeable about the data and, in 

some cases, reviewing documentation about the sources of the data. We 

determined that they were sufficiently reliable for the purpose of 

discussing the results of SBA’s compliance processes. Finally, we 

compared SBA compliance processes to federal internal control 

standards.12

We conducted this performance audit from January 2013 to March 2014 

in accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives.

 

11GAO/AIMD-00-21.3.1.

12GAO/AIMD-00-21.3.1.
Appendix II: Comments from the Small 

Business Administration

Page 52 GAO-14-233 504 Loan Program

Appendix II: Comments from the Small 

Business Administration
Appendix II: Comments from the Small 

Business Administration

Page 53 GAO-14-233 504 Loan Program
Appendix III: GAO Contact and Staff 

Acknowledgments

Page 54 GAO-14-233 504 Loan Program

William B. Shear, (202) 512-8678 or shearw@gao.gov

In addition to the contact above, Andrea (Paige) Smith (Assistant 

Director), Allison Abrams, Benjamin Bolitzer, Pamela Davidson, Rachel 

DeMarcus, Yola Lewis, Daniel McKenna, Marc Molino, Patricia Moye, and 

Jennifer Schwartz made key contributions to this report.

Appendix III: GAO Contact and Staff 

Acknowledgments

GAO Contact

Staff 

Acknowledgments

(250702)
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